Scottish National Investment Bank · most active UK venture capital funder other than crowdfunders....

Scottish National Investment BankImplementation Plan

February 2018

Contents

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ContentsForeword ............................................................................................................................ iiExecutive summary ............................................................................................................ vThe opportunity of a Scottish National Investment Bank ................................................. 1Focus for investment activities ......................................................................................... 9Classification and capitalisation of the Bank.................................................................. 21Governance arrangements .............................................................................................. 26Transition plan .................................................................................................................. 31Appendices ....................................................................................................................... 37Appendix A Terms of reference .................................................................................. 38Appendix B Financial products ................................................................................... 41Appendix C Existing sources of finance..................................................................... 43Appendix D Transition plan summary timeline .......................................................... 45Appendix E Business plan contents ........................................................................... 46Appendix F References ............................................................................................... 47

Contents

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Foreword

Foreword

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“The greater danger for most of us is not that our aim is too high and we miss it, but that it istoo low and we reach it.”

Michelangelo

It was an honour to be asked by the First Minister in the autumn of 2017 to lead an AdvisoryGroup to make recommendations regarding the establishment of the Scottish NationalInvestment Bank (“the Bank”). It has, moreover, been a privilege to work with the AdvisoryGroup and the many who have supported the endeavour over the last few months. Thisreport sets out my recommendations for consideration by Scottish Ministers.

We have engaged with an extensive and broad group of individuals and bodies in both thepublic and private sectors who have generously informed the development of therecommendations. Whilst specific views expressed have been, as one would expect, variedand in some cases opposed, there has been a strong consensus that there is an immediateand pressing need for the creation of the Bank. The development of similar institutions inmany other countries around the world has been very effective in enabling economicprogress.

Independent commentators view the immediate outlook for growth in the Scottish economyas languid at best, in part due to the material risks associated with the unfolding of Brexit andits consequences. It is paramount that we are bold in applying our resources with focus andambition to underpin an inclusive, sustainable point of inflection for the economy. To do sowith confidence we need the Bank to be ambitious – in terms of scale, scope and adaptability– as a necessary condition. But it will not be a sufficient one, since the unequivocal primaryfocus of the Bank will be the provision of debt and equity finance. In order to support theeconomic aspirations of the Scottish Government, the Bank must operate in closecollaboration with other actors such as Scottish Enterprise to engender andsupport ambitious entrepreneurial behaviour in the Scottish economy. As we establish theBank to provide additional financing coverage, we should recognise the success achieved incontiguous investment spheres. For example, recently published research underlinesScotland as home to the strongest regional angel network and Scottish Enterprise as themost active UK venture capital funder other than crowdfunders. Notwithstanding this success,the establishment of the Bank should be embraced as an opportunity to make access tofinance and advisory support easier for SMEs in Scotland. In defining the purpose, vision andstrategy for the Bank, it is vital to say what it is and what it is not. The Bank should befocused primarily on financing, albeit it will necessarily and appropriately offer support to itscustomers. It will not play a primary role in funding or application of grants, nor should theBank compete with private financing such that there is a material risk of ‘crowding out’ privatefinance.

We have undertaken rigorous analysis, leaning on previous studies where possible, todetermine where the Bank could act to complement existing private and publiccontributions to the economic well-being of Scotland. In familiar economic parlance we havesought to identify ‘market failure’ which undermines the potential for inclusive and sociallybeneficial economic growth. The expression ‘market failure’ has negative connotations andcan be unhelpfully divisive. It is perhaps more progressive to think in terms of ‘risk appetite’.That is, existing financing sources focus on specific appetites for risk in terms of the nature ofthe investment and of its likely tenor. By adopting a strategic focus and risk appetite that isdifferent, the Bank can fuel the economy through direct debt and equity investment, and byacting as a catalyst for private investment. Furthermore, many large deals involve foreigninvestors and our participation by share of deals – both by number and by value ofinvestment – is low in comparison with other regions of the UK. The Bank should be capableof amplifying the voice of Scotland in this important regard.

Foreword

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The Bank will invest in a broad range of activities where it can make a complementarycontribution to economic development. It will do so with the twin objectives of making a returnin excess of the cost of capital at portfolio level and by achieving inclusive and socialeconomic benefits. The Bank must be constructed in a manner which enables it to evolveover the long run in response to the changing economic needs of the nation. Equally, at everystage of its development – and perhaps most importantly at the outset – there must beuncompromising prioritisation of resources. An unwillingness to do so would, ineluctably,create an Achilles heel.

The areas identified as opportunities for the Bank fall into three broad categories:

● Support for early stage SME investment

● Scaling up SME investment

● Mission-led, patient long-term investment.

It is critical that the Bank ensures that SMEs have access to micro loan finance through thecontinuation of the existing activities of the SME Holding Fund. But we must also extend theoffering to SMEs by providing short to medium-term loan finance – both senior andmezzanine debt – in the range of £100k to £2m. We should consider specifically – as is beingdone in Ireland – the opportunity and potential to deploy debt funds to support SMEs likely tobe adversely affected by Brexit. The existing Scottish Investment Bank co-investment modelfor early stage equity investment up to £2m should be maintained. A real gap in the marketwhich the Bank must serve, however, is the availability of financing to enable SMEs to scaleup their business and the level of finance involved here is typically in the range of £1m to£10m, sometimes more. The Bank must be focused too on the opportunity for thetransformative change required under the Programme for Government. These projects willoften be defined as ‘missions’ and will enable key participants to coalesce around grandchallenges such as the pursuit of decarbonisation or the adoption of artificial intelligence andmachine learning, rather than being specific to traditional sector classifications. Through theprovision of strategic, patient capital, the Bank will assume an enabling leadership role inindustrial transformation, innovation and the shaping of markets.

We examined the merits of alternative ownership and governance structures. On ownershipwe concluded that Government ownership was clearly preferable to private ownership toensure that the purpose of the Bank could be pursued consistently and with confidence inperpetuity. That conclusion was reached with an assumption that current constraintsassociated with such a structure would be relaxed to allow the Bank to deliver the desiredimpact in the medium and long-term. Needless to say, the level of capital and potentialleverage will need to be commensurate with the intent of the Bank. Appropriate governanceis essential to ensure that the institution operates effectively in a manner consistent with itspurpose, strategy, and values. The approach set out in the recommendations would allow theBank to operate independently under experienced, professional leadership, and withina framework agreed with the Scottish Government in relation to a strategic plan, a riskappetite and reserved matters. Scottish Ministers should also consider establishing anadvisory group to advise Ministers in order to provide representation from a broad range ofconstituencies in the strategic reviews of the Bank. Further consideration should be given tothe chair of this group having a place reserved on the Bank’s Board.

There is an incontrovertible case for the establishment of a Scottish National InvestmentBank. In order for it provide the required stimulus for the Scottish economy, it must haveabsolute clarity of purpose and values, it must have the right expertise and governance, andit must have the courage to prioritise rigorously. And it must do so with ambition.

Benny HigginsFebruary 2018

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Executive summary

Executive summary

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IntroductionThe Scottish Government’s 2017-18 Programme for Government1 committed to establishinga Scottish National Investment Bank to boost Scotland’s competitiveness and realise theScottish Government’s ambitions for the economy by providing patient capital to financegrowth. This commitment was made on strong international evidence that national investmentbanks of scale can lead to a strong, positive impact on investment, innovation and long-termeconomic growth.

Such investment banks have played a key role in the economic development of manycountries, and continue to do so around the world today. The roles performed by NationalInvestment Banks (“NIBs”) have evolved over time in line with country-specific developmentsand challenges. While the traditional functions of NIBs were in infrastructure investment andbroad capital development, their activities have evolved over the course of the 20th century2.Through acting in concert with their governments and other public sector institutions, manyNIBs are steering the path of investment towards specific ‘missions’ and are actively creatingand shaping new markets. By making strategic investments and nurturing new industriallandscapes, they also focus on solving important societal challenges, and have helped othercountries to rebalance domestic economies and reinvigorate their industrial base. Thisrequires patient, long-term, committed finance – typically over a 10-15 year return horizonwhich is beyond the investment horizon for conventional bank lending.

If structured effectively, and with the appropriate attitude to risk and return, a ScottishNational Investment Bank can also play a leading role driving growth and innovation, helpingto transform Scotland’s economy3.

A new cornerstone institution in Scotland’s economic landscapeThe Programme for Government4 builds on the 2015 Scotland’s Economic Strategy5 and setsout a clear economic approach which has at its heart a determination to establish aninclusive, fair, prosperous, innovative country, ready and willing to embrace the future. Itacknowledges that the successful economies of the future will be resource efficient, lowcarbon and harness the power of technology, and illustrates a bold and forward-looking visionof a future-proofed, high-tech, low carbon Scottish economy.

It is apparent that we are now at a critical juncture, with a once in a generation opportunity forScotland to grasp the potential that comes from technical advancement. To unlock suchpotential, the new Scottish National Investment Bank (“the Bank”) will be a cornerstoneinstitution in Scotland’s economic architecture to help realise these possibilities. The Bank willneed to be an innovative and forward looking institution and, as comparator institutionsinternationally have shown, have the ability to adapt to local market conditions and needs.Drawing from this strategic direction, the Bank should adopt the following vision:

“The Scottish National Investment Bank will provide finance and act to catalyse privateinvestment to achieve a step change in growth for the Scottish economy by poweringinnovation and accelerating the move to a low carbon, high-tech, connected, globallycompetitive and inclusive economy.”

The plans for the Bank must be bold, ambitious and based on financial innovation and marketleadership. The Bank should be a catalyst for businesses with growth ambitions, supportingthe acceleration and scaling up of the commercial deployment of innovation, technology

1 Scottish Government (2017), “A Nation with Ambition: The Government’s Programme for Scotland 2017-18(http://www.gov.scot/programme2017)2 Mazzucato, M. and Penna, C. (2016), “Beyond market failures: the market creating and shaping roles of stateinvestment banks”, Journal of Economic Policy Reform, Volume 19 (issue 4): 305-326,(www.sussex.ac.uk/spru/documents/2014-21-swps-mazzucato-and-penna.pdf)3 Mazzucato, M. and Macfarlane, L, (2017), “Patient strategic finance: opportunities for investment-led growth in theUK”. UCL Institute for Innovation and Public Purpose, Working Paper Series (IIPP 2017-05)www.ucl.ac.uk/bartlett/public-purpose/wp2017-054 Scottish Government (2017), A Nation with Ambition: The Government’s Programme for Scotland 2017-18(http://www.gov.scot/programme2017)5 Scottish Government (2015), Scotland’s Economic Strategy (https://beta.gov.scot/policies/economic-growth)

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advances and R&D, and investing in cross-sectoral projects and initiatives that will helptransform Scotland’s local, regional and national economies. Where it identifies need, it willinvest and lend on commercial terms, but with a different risk appetite to other financierswhere required and appropriate, taking a longer term view on returns. The Bank will be anearly investor in new and emerging market opportunities seeking to crowd-in investors andfunders to help establish new financing markets aligned with the Scottish Government’spriorities for the economy.

A vision for the Bank aligned to Scottish economic policyThe Bank should be an enduring institution, set-up as a public sector institution in perpetuitythat aligns with the Scottish Government and its agencies to provide financing leadership.Close alignment between the Bank and government policy – both economic and social –should help create a powerful connection between policy, regulation and financing which canbe co-ordinated for maximum impact6.

The direction of policy, together with the activity and support of the Bank, will createconfidence in the private sector to invest where previously they would not have done. Thiswill enhance the effectiveness of the Scottish Government’s interventions and allow a longerterm view to be taken by business, investor and the Scottish Government itself.

Focus of activitiesThe Bank should develop financial products to help realise growth opportunities across theeconomy, with a particular focus on innovative and productive sectors. It should have thecapability to provide capital across all stages of the business growth lifecycle and ensure that,where there are gaps or opportunities, it can address these through a range of financialproducts. Critically, it should focus activities on areas which can contribute most to the policy-driven missions identified by the Scottish Government.

Because innovation is highly uncertain and has long lead times, achieving smart, innovation-led growth requires not just any type of finance, but patient finance. The Bank should,therefore, provide access to long-term patient finance where need exists.

To build on the success of existing operations and the clear alignment with the Bank’sagenda, the financing activities undertaken by and on behalf of the Scottish Government,such as Scottish Enterprise’s Scottish Investment Bank and the provision of funding for loanand equity finance schemes (for example, under the SME Holding Fund and the ScottishGrowth Scheme) should sit within the Bank allowing the Bank to utilise the strengths andskills already developed and build on the positive foundations laid by the work of the ScottishGovernment and its agencies.

This consolidation will ensure a greater coherence for those firms looking for finance bysimplifying the existing public sector landscape. Issues affecting the demand for finance,such as reluctance to take on equity funding or lack of knowledge on the funding options canbe an inhibitor to growth, and the coherence of the public sector offer is an important part ofaddressing this. It will also ensure the efficiency of public sector activity in this area throughenabling the Bank to best direct its capital across the existing financing activity and newactivities, utilising existing channels to market and investor relationships. The full details ofthe integration and alignment should feature as an explicit strand of the plan to progress theBank’s set-up.

6 Macfarlane, L. and Mazzucato, M. (2018), “State investment banks and patient finance: An internationalcomparison”, UCL Institute for Innovation and Public Purpose Working Paper, IIPP-WP 2018-01.

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Existing business advice and support provided on behalf of Ministers by the enterpriseagencies and infrastructure advice via Scottish Futures Trust should also be co-ordinatedwith the Bank’s activity, so that the whole ecosystem works effectively together to achieve themission-led objectives set by Scottish Ministers enabling businesses and the economy toflourish.

The Bank’s activities should also be aligned with non-Scottish Government financing activityin Scotland, including that of the British Business Bank, to ensure that access andopportunities for financing, investment and economic growth are complementary andmaximised. The Bank should seek to lead the development of a co-ordinated strategy toachieve this.

Building on the existing supply of finance, the immediate areas of additional activity requiredfor the Bank to deliver most impact are expected to be:

● Growth Capital: Supporting companies’ growth ambitions, including those businesseswhich are driven by knowledge and ideas rather than operating with a strong base offixed and tangible assets. The Bank should do this by providing access to long-termpatient finance necessary for ambitious firms to invest in order to grow and turn theirideas into revenues, and also seek to address recognised gaps in the current market forlending to SMEs whose need for finance may be over a short to medium-term horizon.

● Financing projects that will transform the economy: To achieve this transformativemission-based remit of the Bank, there will be a need for investment in projects that willhelp Scotland exploit and accelerate new innovation – these are the ‘big ideas’ for theeconomy such as the transition to a low carbon economy. Such projects may require theBank to play a catalytic role in infrastructure investment (across transport, low carbon,housing, real estate, etc.) providing finance that addresses the reasons why the privatesector is not investing.

The initial financial product range that the Bank should focus on is:

● Provide SMEs with access to micro loan finance of up to £100k by the continuation ofthe existing activities enabled by the Scottish Government’s SME Holding Fund

● Expand the offerings of loan finance to SMEs by providing short to medium-term loanfinance (senior and mezzanine debt) in the range between £100K and up to £1m-£2mfor which there is currently unsatisfied demand

● Consider the potential to deliver targeted debt support through the creation of specificloan funds such as the recently launched Brexit Loan Fund being established by theStrategic Banking Corporation of Ireland

● Provide early stage risk capital equity up to £2m currently provided by the ScottishInvestment Bank via its co-investment funds

● Provide other targeted equity and mezzanine investment models for amounts up to £2m,whilst also providing scale-up investment finance by way of equity and loans up to £10m,and above, where opportunities are identified

● Mission-based finance could be both debt and equity depending on the analysis of thegap or market opportunity, but focused on the transformative change agenda set by theProgramme for Government.

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It will be for the Bank itself to develop detailed product offerings. There should be apresumption, as with existing activity, that those offerings aim to maximise additionality(measured in financial, economic, social and environmental terms), but within the bounds ofthe Bank being financially self-sustainable.

Acting commercially, the Bank should target a positive financial return at both an individualinvestment level and at an investment portfolio level – with the portfolio return target set overthe long-term. Investment should be on an ethical basis and to guide this principle the Bankshould develop a code of ethics that goes beyond regulatory requirements and adopts a bestpractice approach.

The Bank should focus on, and give priority to, areas of investment that are additional to thefinance already provided by the market and by other providers in Scotland. Through doing so,it will complement rather than crowd-out existing or potential investment. As a Governmentbacked investor the Bank will provide increased confidence to the private sector to co-investas seen with SIB’s existing investment activity.

The Bank will need the capability to make direct investments, especially for largertransformative projects which will take time and effort to develop the opportunities andfinancing solutions. This is an area where close co-ordination of effort will be requiredbetween the Bank, the Scottish Government and other public sector bodies.

Much of the Bank’s investment and lending activities with companies, will be through others.This requires fund management capability or the development of its own asset managementstructures. In order to reach growing firms, the Bank’s partnership working with the enterpriseagencies in particular and other market participants will be essential.

A clear understanding of the remit of the Bank will be critical to its success, as will a focus onspecific areas where it will operate. Several activities are excluded due to an inappropriate fitwith the Bank’s remit and/or for operational reasons. These include:

● The Bank will not offer traditional banking services such as taking deposits or offeringmortgages, and as such it will not require a network of branches

● It will not undertake funding activities, such as the awarding of capital and revenuegrants which will remain with the Scottish Government and its agencies.

As the Bank will not be a deposit taking institution it will not require a banking licence. Thisenables the Bank to have much more flexibility over where and how it invests in the economyby not being bound by banking regulation.

Classification and capitalisationThe Bank should be set up as a limited company, wholly owned by the Scottish Governmentwith an independent Board to oversee operations. This enables the Scottish Government toset up the Bank at arm’s length and enables it to act more freely and flexibly in the marketthan a regulated bank in order to achieve the objectives set for it by Scottish Ministers. TheBank should be a public body, classified to the public sector to ensure direct alignmentbetween the activities of the Bank, the broader economic policy and the ScottishGovernment’s enterprise and skills agencies.

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The Bank should be capitalised over time by the Scottish Government. An early commitmentto this has been made by the Scottish Government in the 2018-19 Draft Budget with anundertaking to provide initial public capital of £340m for 2019-20 and 2020-21. The DraftBudget also established a new £150m Building Scotland Fund (£80m in 2018-19 and £70m in2019-20). It is proposed that this fund’s remit, and investments made, transfer to the Bank in2019-20 when it is operating in interim or ‘shadow’ form, pre-incorporation.

To achieve a step change in the supply of finance, the target level of public capital for theBank should be a minimum of £1bn over the first five years and a further £1bn over years 6 to10 (this excludes the funding of the existing financing activities to be brought under the remitof the Bank). A public capitalisation at the level of £2bn – equating to around 1.3% ofScotland’s GDP – is in line with international comparators.

The Bank should reinvest its financial returns, both capital and interest, to create a self-sustaining, lasting institution with increasing influence on the Scottish economy. To achievethis ambition, there are three key milestone objectives:

● To secure a dispensation from HM Treasury to have the flexibility to manage, retain andcarry-forward cash balances over financial year-ends. This is required by the time theBank is established

● To be self-funding, meaning that the Bank covers its operating costs from investmentreturns. Given the longer term investment horizon of the proposed investment activities,this objective may not be achieved until the medium-term

● To be able to raise capital in its own right and no longer be reliant on capital advancesfrom the Scottish Government to fund its investments. Further dispensation from HMTreasury will also be required for this.

GovernanceThe Bank’s investment mandate should come from the Scottish Government via a StrategicFramework.

The Bank should have a Board, with the Chair of the Bank and Non-Executive BoardMembers appointed by Scottish Ministers, but it is envisaged that the Executive ManagementTeam appointments will be made by the Board.

The structure of the Bank should enable it to enter into a range of activities to supporteconomic growth in Scotland by providing targeted financing solutions. A ‘Top-co’arrangement with a series of subsidiaries (for example, to enable co-investment funds) wouldbe the most appropriate operating model to maximise the flexibility of the Bank’s investmentactivities and private sector investment.

Given the scale of ambition for the Bank, and the associated scope of activity, the potentialrunning costs for the Bank when fully established are estimated to be between £20m-£30mper annum. This would allow for an organisation that would have circa 100-150 peopleworking for it and engaging in a full range of financing activities.

Importantly, to augment the governance arrangements and ensure that the Bank hasappropriate societal representation, the Scottish Government should assess the optimalmeans of ensuring effective representation with stakeholders and wider civic society. Thisreport recommends establishing an advisory group as one option to achieve this with itspurpose to advise the Scottish Government on the Strategic Framework, and with the Chairof this group having a place on the Bank’s Board as a Non-Executive Director.

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TransitionThere are a number of key activities that need to take place in order for the Bank to be a fullyoperational, independently run, institution, including: passage of a Bill through the ScottishParliament; agreeing the dispensation from HM Treasury; agreement of the operating model;integration of existing activities and people; and investment in additional people and systems.The Bank should be established as a legal entity and become fully active during 2020following the legislative process.

To provide strategic direction to the transition process, a shadow Chair should be appointedas soon as possible in 2018 to oversee the project team formed to deliver the transition andestablishment of the Bank. With a view to be operating in a shadow form in 2019, a shadowBoard and interim Executive Management Team should also be appointed in advance todevelop the initial Investment Strategy and Business Plan for 2019-20.

The work to establish the most effective operating model for the Bank should be agreedduring 2018. This should include how it will assume responsibility for activities currentlyprovided by others, allowing these skills and knowledge to be available to the Bank. Ashadow bank structure should be operational in 2019 overseeing existing financing activitieswhich are relevant to the Bank and managing new funding made available to the Bank aswell as implementing its plans to be fully operational during 2020. Being active as a shadoworganisation in 2019 will provide a clear sign of progress and momentum.

SummaryThe vision set out here for the new Bank is one with the scope and scale to betransformational to the Scottish economy. It will coalesce with the wider economic landscapearound a number of critical missions helping Scotland to harness its full economic potential.

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Recommendations

The recommendations set out within the Implementation Plan are summarised below.

No. Recommendation

1 A national investment bank should be established for Scotland with a vision to “providefinance and act to catalyse private investment to achieve a step change in growth for theScottish economy by powering innovation and accelerating the move to a low carbon, high-tech, connected, globally competitive and inclusive economy.”

2 The Bank’s strategic priorities for investment should be centred on a core role of helping toaddress Scotland’s economic priorities in an inclusive and ethical way.

3 This new, mission-led institution will actively create and shape markets. It will intervene in avariety of areas – to supporting early stage and smaller firms and larger scale innovativeprojects get access to investment, through to financing infrastructure where the private sectorwill not invest. The initial focus of the Bank should be:• Providing growth capital to ambitious and innovative companies – with the capability to

support across the lifecycle of a company’s need for capital.• Providing finance to support the projects and initiatives aimed at realising opportunities to

transform the economy.The Implementation Plan sets out a range of financial products that the Bank should seek todevelop to support this initial focus.

4 In addition to the supply of capital, the Bank should coordinate with other entities seeking tostimulate demand for financing. In financing transformational projects, the Bank will needfinancial structuring and complex transactional skills and consequently an element of demandstimulation will be required in this area, working closely with the enterprise agencies whoprovide a range of support services to companies, and with the Scottish Futures Trust inrelation to its activities on infrastructure.

5 The Bank should aim to focus on, and give priority to, areas of investment that are additionalto the finance already provided by the market and by other providers in Scotland,complementing rather than crowding-out existing or potential investment.

6 The Bank should adopt a balanced portfolio approach across a range of potential productsand asset types. Its target should be to achieve a positive financial return on its individualinvestments, and at a portfolio level which should be measured over at least a 10-15 yearhorizon, recognising the focus on investment in patient capital and transformativeinfrastructure.

7 Scottish Ministers should determine an appropriate basis for measuring the Bank’sperformance, taking into account the long-term nature of the investments and mission-orientated approach that’s envisaged for the Bank. A balanced scorecard approach is requiredthat reports on the financial performance as well as on economic impact over time, includingsocial, environmental and ethical returns.

8 The Bank should seek to maximise leverage of private capital as appropriate, alongside itsown investments. In doing so, it should adopt a flexible approach; it may be appropriate for theBank to invest or lend directly alongside private sector investors through third party deliveryagents or via external funds.

9 The Bank should build on current skills and experience successfully developed in Scotland,building on the track record of success, and creating a single point of delivery of financingsupport for business growth and innovation financing for transformational projects.A detailed review will be required in response to this recommendation in order to achieve theoptimal operating model and ensure essential close interaction between the Bank and theenterprise agencies, including how to ensure co-ordination of funding, company relationshipsand financial readiness activities that will be provided by the agencies.

10 The Bank’s activities should be aligned with the activities of the British Business Bank inScotland, which may require establishing a strategy for alignment between both institutions.

11 The Bank should be established as a public body to ensure a continued focus on the Scottisheconomic strategy and alignment with a mission-based approach to investment. The form ofpublic body should ensure maximum flexibility in how the Bank invests.

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No. Recommendation

12 Long term, mission-orientated investment requires a long-term capitalisation and fundingcommitment by the Scottish Government. The target level of initial capitalisation is £1bn fornew activity, provided over the first five years followed by a further £1bn over years 6-10.

13 Three essential milestones should be set for implementation and successful operation of theBank at the scale envisaged:• To be set-up with the flexibility to manage, retain and carry-forward cash balances over

financial year-ends• To become self-funding over the medium term that is; the Bank covers its operating costs

from investment returns• To be able to raise capital in its own right and no longer be reliant on capital advances

from the Scottish Government to fund its investments.

14 As sole shareholder and sponsor of the Bank, Scottish Ministers will need to set theparameters within which the Bank should work. To do this Ministers should set a five yearStrategic Framework for the Bank to respond to in its Investment Strategy and Business Plan.The reporting framework should ensure the highest standards of transparency andaccountability.

15 The Bank should be administratively and operationally independent of Scottish Ministers. TheBoard should include a Chair and non-Executive members appointed by Scottish Ministers,and two Executive Directors in the shape of the Chief Executive Officer and Finance Director.There should be an appropriately experienced and professional Executive ManagementTeam.

16 The Scottish Government should consider how best to consult with wider stakeholders onsetting the Strategic Framework for the Bank to ensure that there is broad engagement withcivic society on how the Bank is operating. This report recommends that an advisory groupshould be established whose membership comprises representatives from stakeholders andwider civic society. The group should advise Ministers on the Bank’s Strategic Framework.The Chair of this advisory group could be on the main Bank Board as a Non-ExecutiveDirector.

17 The Bank should establish and operate to the highest standards of transparency,accountability and management of risk. This should be reflected in the reporting andaccountability arrangements to be put in place, and in the formal governance arrangements ofthe Bank.

18 In setting up the Bank, Ministers should appoint an independent shadow Chair as soon aspossible, to oversee the work of a project team responsible for the transition and set-up of theBank. A shadow Board and interim Management Team should be put in place prior to theBank operating in shadow form in 2019.

19 Scottish Ministers should concurrently confirm the Bank’s initial missions and the firstStrategic Framework, ensuring that the essential clearances and changes required areobtained from HM Treasury and others.

20 The Bank will need staff with the right mix of skills and experience to ensure its success andsustainability. The Scottish Government should ensure that the Bank can offer employmentand remuneration terms which are sufficiently competitive to attract suitably skilled andexperienced people.

21 The Bank should adopt a leadership role with regards to diversity and inclusiveness within itsgovernance, operational arrangements and investment strategy.

The Implementation Plan set out overleaf provides detail behind each of the aboverecommendations.

The Scottish Government has prepared an analytical document of supporting evidence tosupport the findings set out in this Implementation Plan.

Abbreviations

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Abbreviations

Abbreviation DetailBBB British Business Bank

BEIS Department for Business, Energy and Industrial Strategy

BERD Business Expenditure on Research and Development

BVCA The British Private Equity and Venture Capital Association

CEA Council of Economic Advisors

CEO Chief Executive Officer

DBFM Design, Build, Finance and Maintain

EIB European Investment Bank

ERDF European Regional Development Fund

EU European Union

FCA Financial Conduct Authority

GBER General Block Exemption Regulation

GDP Gross Domestic Product

GIB Green Investment Bank

HM Treasury Her Majesty’s Treasury

IP Implementation Plan

IRR Internal Rate of Return

JESSICA Joint European Support for Sustainable Investment in City Areas

MEOP Market Economy Operator Principle

NDPB Non-Departmental Public Body

NEDs Non-Executive Directors

NHT National Housing Trust

NIB National Investment Bank

NPB National Promotional Bank

OBR Office for Budget Responsibility

OECD Organisation for Economic Co-operation and Development

OMSE Open Market Shared Equity scheme

ONS Office for National Statistics

PWLB Public Works Loan Board

REIF Renewable Energy Investment Fund

R&D Research and Development

SCF Scottish Co-Investment Fund

SE Scottish Enterprise

SEGCP Scottish European Growth Co-investment Programme

SFC Scottish Fiscal Commission

SFT Scottish Futures Trust

SFTi Scottish Futures Trust Investments Limited

SG Scottish Government

SIB Scottish Investment Bank

SME Small or Medium Sized Enterprise

SPRUCE The Scottish Partnership for Regeneration in Urban Centres

SVF Scottish Venture Fund

The Bank Scottish National Investment Bank

The Commission The European Commission

UKEF UK Export Finance

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The opportunity of a Scottish NationalInvestment Bank

The opportunity of a Scottish National Investment Bank

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National Investment Banks of scale are successful across the globeNational investment banks (“NIBs”) play a key role in the economic development of manycountries, with over 90 institutions existing across different countries and regions around theglobe.7

In recent years, the more successful NIBs have taken on a new role as key domestic andglobal actors driving economic growth and innovation, particularly through addressingcontemporary challenges such as climate change. By making strategic investments andnurturing new industrial landscapes, their focus on solving important societal challenges (a“mission-oriented” approach) has helped to rebalance their economies and reinvigorate theindustrial base. These institutions act in concert with their governments and help achievelong-term objectives.

A mission-oriented approach to industrial policy has helped to determine the direction ofgrowth by making strategic investments across many different sectors, and improvingbusiness expectations about future growth areas. This requires patient, long-term, committedfinance – typically over 10-15 years which is beyond the investment horizon for conventionalbank lending.

By developing new financial tools and working closely with public and private stakeholdersNIBs can, if structured effectively and with the appropriate attitude to risk and return, play aleading role in driving growth, innovation and industrial transformation. By steering the path ofinnovation towards missions set by government, these NIBs are not just correcting issues inexisting markets (a “market failure” approach in the common terminology), but are activelycreating and shaping markets. They are enabling activity that otherwise would not take place.

A new cornerstone institution in Scotland’s economic landscapeThe modern era, with the unprecedented pace of technological change, is having hugeeconomic, societal and environmental impacts across the globe. Governments and capitalmarkets need to respond to these challenges in a new and co-ordinated way at a strategiclevel, including stimulating investment across sectors to address complex challenges.

There will be opportunities for business to capitalise on these changes, and first-moveradvantages to those countries who mobilise resources most efficiently. Scotland is wellplaced to do this. It has a scale that facilitates collaboration, combined with the human andnatural resources required to seize the economic opportunities of the future. Scotland has thepotential to demonstrate global leadership on common challenges such as transitioning to alow carbon economy, population health and demographic change, as well as harnessing thepowers of rapid technological development to provide benefits to all across society.

The new Scottish National Investment Bank (“the Bank”) should be a cornerstone institutionin Scotland’s economic architecture to help realise these possibilities, building on the successof the Scottish Government’s (“SG”) current support mechanisms.

7 Mazzucato, M. and Macfarlane, L. (2018), State Investment Banks: Selected International Case Studies which hasbeen published by the Scottish Government alongside this Implementation Plan.


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It should be set up to be an enduring institution that aligns with SG and its delivery agenciesto provide critical economic leadership. By applying robust data analysis and developingevidence, it should respond to well-defined missions that are focused on solving importantsocietal challenges. This will provide policymakers the opportunity to determine the directionof growth by facilitating strategic investments across many different sectors and nurturingnew industrial landscapes, which the private sector can further develop.

Close alignment between the Bank, other public sector agencies and government shouldcreate a powerful connection between policy, regulation and financing which can be co-ordinated for maximum impact. The direction of policy (both economic and social) togetherwith the activity and support of the Bank, will create confidence in the private sector to investwhere previously they would not have done. This will enhance the effectiveness of SG’sinterventions and allow a longer term view to be taken by business, investor and SG itself.

A vision for the Bank aligned to Scottish economic policyScotland has a distinct economic policy environment with Scotland’s Economic Strategy8

establishing four key priorities for growing the economy. These priorities cover investing inpeople and infrastructure, fostering innovation, promoting Scotland internationally andinclusive growth – the notion that growth which combines increased prosperity with greaterequality creates opportunities for all and distributes the benefits of increased prosperity fairly.

Scotland’s Programme for Government builds on this. In its own words, it:

“…sets out a bold and forward-looking economic vision – sending a clear message to ourpeople, businesses, schools, colleges and universities, and to the wider world: Scotland’sambition is to be the investor and the producer, not just a consumer, of the innovations thatwill shape the lives of our children and grandchildren.

We will seize the economic opportunities of tackling climate change, helping existingindustries adapt to the future and using developments in data and digital technology to makeour economy more competitive, productive, innovative, fair and profitable.”

It is apparent that we are now at a critical juncture, with a once in a generation opportunity tograsp Scotland’s competitive advantage which can deliver this potential. To unlock suchpotential, the Bank will need to be an innovative and forward looking institution and, ascomparator institutions internationally have shown, will need to have the scope and scale toadapt to local market conditions and needs.

Drawing from this strategic direction, the Bank should adopt the following vision:

“The Scottish National Investment Bank will provide finance and act to catalyse privateinvestment to achieve a step change in growth for the Scottish economy by poweringinnovation and accelerating the move to a low carbon, high-tech, connected, globallycompetitive and inclusive economy.”

8 Scottish Government (2015), Scotland’s Economic Strategy (https://beta.gov.scot/policies/economic-growth)


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The current economic outlook is challengingThe vision for the Bank is for a long-term cornerstone institution at the heart of the Scottisheconomy. It is useful to set this in the context of the current economic climate.

The current Scottish Fiscal Commission (“SFC”) economic forecasts9 are for modest growthover the period to 2021, below the pre-2008 long-term trend (see Figure 1). The forecast ispartially driven by SFC assumptions about productivity growth in the Scottish economy andpartly by the modelled impact of the UK leaving the European Union (“EU”). The Office ofBudget Responsibility (“OBR”) for the UK as a whole show a similar picture although they aremore optimistic in their central projection10.

Figure 1: GDP growth in Scotland: outturn and forecast

The SFC has taken a more pessimistic view of the impact of Brexit than the OBR. The SFCtake the view that EU migration will be significantly lower than recent trends and that therewill be an adverse impact on trade. At the time of writing, the future relationship with the EUwas unclear, but SG analysis published in January 201811 provides new evidence of thesubstantial costs resulting from lower economic growth and lower business investmentopportunities in Scotland and the UK that will result from leaving a market in excess of 500million people. Scotland’s GDP could be as much as 8.5% (or £12.7 billion) lower by 2030and business investment in Scotland could fall by up to 10.2% by 2030, compared tocontinued EU membership.

9 Scottish Fiscal Commission (2017), Scotland's Economic and Fiscal Forecasts December 2017,(http://www.fiscalcommission.scot/publications/scotlands-economic-and-fiscal-forecasts/scotlands-economic-and-fiscal-forecasts-december-2017/)10 The SFC forecasts for Scotland are close to the 4th decile of the spread of OBR forecast variation. See Chart 1.4 ofthe Economic and Fiscal outlook; Office for Budget Responsibility (2017), Economic and fiscal outlook – November2017, (http://obr.uk/efo/economic-fiscal-outlook-november-2017/) http://obr.uk/efo/economic-fiscal-outlook-november-2017/11 Scottish Government (2018), Scotland's place in Europe: people, jobs and investment,(https://beta.gov.scot/publications/scotlands-place-europe-people-jobs-investment/)


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The potential economic benefit of establishing the BankSG’s Council of Economic Advisers (“CEA”) has previously set out the importance toScotland’s economic growth of supporting infrastructure development, providing finance forhigh growth businesses, and supporting strategic investments in innovation through asubmission to the consultation on the Green Paper for the UK’s Industrial Strategy12. Thework of the CEA recognised the scale and scope of existing SG investment and interventionin infrastructure and business development, but also identified the potential for a ScottishNational Investment Bank to support the delivery of long-term investment to boost economicdevelopment.

In particular, the CEA highlight a number of issues around patient capital which arefundamental to long-term growth, and where a NIB could stimulate stronger economic growthacross Scotland. These include:

● The need to achieve higher levels of long-term investment in SMEs: Hightransaction costs and what are termed “information asymmetries” can lead to an undersupply of finance for SMEs (a problem traditionally known as the ‘Macmillan gap’). Bothdebt and equity providers tend to prefer the lower aggregate transaction costs of largerdeals, and are reluctant to spend the extra time and cost to support some types ofinvestment. It is also easier to invest in firms with longer track records and where returnsare more predictable than newer firms, where returns are less certain and further in thefuture.

● The need for improved innovation performance: According to the EuropeanCommission’s Regional Innovation Scoreboard, Scotland is classed as an innovation‘Follower’. It ranks around the middle of EU countries across a composite of innovationindicators. Scotland’s overall expenditure on R&D as a percentage of GDP is low relativeto comparator countries. Within this, Scotland performs particularly poorly in terms ofBusiness Expenditure on R&D (BERD), ranking fifth amongst sixth comparatorcountries.

A further unique feature of the Scottish investment landscape lies in the success and volumeof investment by universities and other academic institutions. In 2012, for example,Scotland's higher education R&D expenditure as a percentage of GDP was the fourth highestin the OECD, with half of Scotland's University research being assessed as world-leading orinternationally excellent. This makes the relative lack of technology companies based inScotland starker, and points to a missed opportunity to use the intellectual capital thatScotland has in abundance.

The CEA also focused on the support for patient capital within a devolved Scottish context,and the constraints within the current UK institutional arrangements. They specificallyhighlighted the persistent gap in the provision of microfinance, debt and early stage equity forsmall and medium enterprises, and growth capital in amounts up to £10m. In addition, thedependency on European funding sources was noted as significant in Scotland and highlightsthat Brexit could have significant implications for support for business development fundingand infrastructure investment in the coming years.

In order to achieve its full potential and deliver the maximum level of economic benefit toScotland, the operations of the Bank should be based on a deep and comprehensiveunderstanding of the unique and varied characteristics of the Scottish economy. As with thestrongest-performing NIBs elsewhere, it should establish a sharp and dedicated focus on thespecific set of conditions which it faces. For example, we know there is significant variation inthe industrial composition and productivity performance across – and within – UK regions.Productivity across the whole UK demonstrates significant variation, with London and theSouth East clearly outstripping other regions’ performance (see Figure 2).

12 Scottish Government (2017), Council of Economic Advisers: building our industrial strategy,(https://beta.gov.scot/publications/uk-government-green-paper-building-our-industrial-strategy/)


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Figure 2: Regional and sub-regional productivity

In addition to this, Scotland’s sub-regional productivity performance is more broadly diversethan all regions other than the North West, South East and London. While four Scottish sub-regions demonstrate productivity levels above the UK average (Aberdeen City &Aberdeenshire; the City of Edinburgh; Inverclyde, East Renfrewshire & Renfrewshire; andSouth Ayrshire), there are many that continue to lag substantially behind.

This view of sub-regional performance is reinforced by a similar comparison of wider factorsthat shows the variation between Scotland and the rest of the UK is even more marked.Figure 3 shows the different relative performance of UK regions against OECD regions by arange of measures of well-being.

Figure 3: "Well-being" performance of UK regions against rest of OECD


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Scotland scores highest in the UK on Community, Life Satisfaction and Civic Engagement,and poorest on Access to services (as well as Health). But what is equally pertinent is thatScotland is the most extreme (top or bottom of the ranking) in the UK in these five categories,a total that is only surpassed by Greater London (six), which confirms the differencesbetween Scotland and other (regional) parts of the UK.

Coupled with the divergence in the policy environment between Scotland and the rest of theUK – for example in housing, where there are now wide differences in legislation aroundhomelessness and the nature of tenancies as well as a different approach to provision – thisvariance and specificity of local conditions in Scotland means that local experience,knowledge and focus will be required to deliver the benefits that the Bank can offer.

To give an idea of the macro-economic impact the bank could make, initial economicmodelling undertaken by SG on behalf of the Implementation Plan suggests that whilst therewill be benefits in the short-term from any additional investment made by the bank, the realprize will be how the bank is able to influence productivity and the overall liquidity ofinvestment in the longer term. To give an idea of the macro-economic impact the bank couldmake, initial economic modelling undertaken by the Scottish Government on behalf of theImplementation Plan suggests that whilst there will be significant benefits in the short termfrom any additional investment made by the bank, the real prize will be how the bank is ableto influence productivity and the overall liquidity of investment in the longer term. (For furtherdetail see the accompanying Supporting Analysis paper.)

Consultation feedbackThe responses received as part of the consultation process were overwhelmingly positivetowards the proposition of a national investment bank. Respondents were keen to engagewith the development of the Bank’s scope and investment strategy. The responses suggestedthat there was a broad appetite across Scotland for a wider scope of support within theScottish investment landscape and a requirement for additional capital. A number ofrespondents also cited that this was an opportunity to adopt a more ethical, socially just andenvironmentally aware investment strategy.


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SummaryThere is a strong and clear argument that the supply of capital to an economy through a NIBcan fix market failures and address gaps in the financing markets for companies seekingfinance to grow. A NIB can provide strategic leadership to support, create and shape newmarkets for investment and drive innovation targeted at particular economic, social andenvironmental objectives.

The strategic and economic cases for establishing a national investment bank in Scotland arecompelling, supporting the economic ambitions of SG and the change and growth which willsecure the nation’s future. Review of the impact that international comparators have had ontheir respective economies provides confidence that such a Bank will enhance theperformance of the Scottish economy.

Having an institution based in Scotland is important in order to connect its activities to aneconomy that is distinct from the rest of the UK in terms of geography, sector focus,infrastructure requirements and the supply and demand for capital to finance businessgrowth.

RecommendationsRecommendation 1: A national investment bank should be established for Scotland with avision to “provide finance and act to catalyse private investment to achieve a step change ingrowth for the Scottish economy by powering innovation and accelerating the move to a lowcarbon, high-tech, connected, globally competitive and inclusive economy.”

Recommendation 2: The Bank’s strategic priorities for investment should be centred on acore role of helping to address Scotland’s economic priorities in an inclusive and ethical way.

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2Focus for investment activities

Focus for investment activities

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The scope of the BankThe Bank should be set-up to be an enduring institution that provides a step change inScotland’s economic architecture. It should unlock the potential for improved performance byproviding the finance to help Scotland’s businesses to realise new economic opportunities athome and abroad. It should do this by developing financial products to help realise growthopportunities across the economy, with a particular focus on areas that have a strong degreeof innovation. Critically, it should focus activities on areas which can contribute most to thepolicy-driven missions identified by SG.

Financing this transformative change in an economy will require an institution that can bothtake a long-term approach which extends beyond the typical terms for private sectorinvestment, and is prepared to act to make and shape markets in support of missions thatdefine how the economy will develop.

Because innovation is highly uncertain and has long lead times, achieving smart, innovation-led growth requires not just any type of finance, but patient strategic finance. The Bankshould, therefore, provide access to long-term patient finance, with a return in the 10-15 yearhorizon.

The Bank should have the capability to operate across all stages of the capital lifecyclerequirement for companies (see Figure 4 in respect of equity investment stages) and byfinancing products such as senior debt, equity and mezzanine finance. In doing so, it shouldensure that a range of financial products – where there are gaps or market-makingopportunities – are available to Scottish businesses to support growth and bring clarity andsimplicity to the end-user and consequently helping to reinforce demand for finance.

Figure 4: Equity capital lifecycle visual

Source: Scottish Government

The Bank should provide greater depth of access through provision of sufficient scale toenable transformative investments. This greater scale should also increase the demand forfinance by acting as clear signal of ambition.

Gaps in the financing markets and mission-based financeMarket gapsThere is longstanding evidence of market gaps in access to finance and particularly in capitalthat enables firms to grow. Growth is uncertain, so returns dependent on achieving growthcan be seen as more uncertain and higher risk. This is especially true where firms are smallto begin with as it can be difficult to ascertain which growth plans have the potential tosucceed. Not only this, but developing the expertise, analytics and relationships to enablegood judgements to be made is expensive, meaning that finance providers such as banksand private equity firms often prefer larger transactions (and in the equity space, leveragedtransactions).


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These challenges mean that in a number of areas, viable firms with good growth plans canfail to find the finance they need. This has been attested in a number of studies, from theMacmillan study of 1931 onwards – including the Rowlands Review of Growth Capital13. Moredetail and analysis on market gaps is contained within the Supporting Analysis report thataccompanies this Implementation Plan.

A further issue for growth capital is the time taken for returns to come where markets need tobe developed. Time has the effect of lowering the annual rate of return if returns are notmade quickly enough, and of increasing the risk of issues arising that reduce returns. Thismeans that ‘patient capital’ can be scarce and this can affect the availability of capital forgrowth.

The Patient Capital Review14, commissioned by the UK Government, illustrates there areclear barriers in accessing long-term, patient capital in the UK’s under-developed andfragmented ecosystem. The review identifies several specific barriers to investment in patientcapital including that the majority of financing is concentrated in London and, therefore, it isparticularly difficult for businesses outside the capital to access the funding they require.

For gaps in the provision of lending to SMEs, it is important to look at specific circumstancesand also how finance markets change over time. SG has developed analysis that suggeststhere are issues that affect the Scottish economy in the following areas:

● Debt gap – Estimated to range between £330m and £750m per year in Scotland15. Gapsexist from the very smallest levels of finance (microfinance from £500 to £25,000) andfrom £25,000 to £100,000 and extend up to £1m-£2m.

● Equity finance gap – The British Business Bank (“BBB”) highlighted the structural marketfailures in its 2015 investigation into the provision of equity16 and pointed to theinformation asymmetry between business and investor which necessitates costly duediligence in advance of any deal which is relatively fixed, meaning it accounts for agreater share of smaller deals, which drives investors towards larger deals and larger,less risk orientated firms. This gives rise to the classic “equity gap” first identified in theMacmillan study as long ago as 1931. As the market is becoming ever more complexand dynamic there are no longer fixed and easily identified gaps to address.Nevertheless, there is agreement17 that there is also now a growing acute gap at thelater stages, especially for innovative, growth companies seeking to scale up, at the £2mto £10m level. Within that grouping of companies, the gap particularly applies to pre-revenue and pre-profit companies and for those with delayed cash flows or in need ofsignificant product development time, whereas capital is more likely to be available forthose with a proven business model.

13 Rowlands, C. (2009), The Provision of Growth Capital to UK Small and Medium Sized Enterprises(http://lincscot.info/wp-content/uploads/2016/12/rowlands-growth-capital-review.pdf)14 Buffini, D. (2017), Patient Capital Review: Industry Panel Response, UK Government: London, UK(www.gov.uk/government/publications/patient-capital-review)15 Scottish Government, 2015 The Market for SME Finance in Scotland,(http://www.gov.scot/Publications/2015/08/3776)16 British Business Bank (2015), Equity Research Report: Review of Equity Investment in Small Businesses,(http://british-business-bank.co.uk/wp-content/uploads/2015/03/050315-Equity-report-FINAL.pdf)17 Buffini, D. (2017), Patient Capital Review: Industry Panel Response, UK Government: London, UK(www.gov.uk/government/publications/patient-capital-review)


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Developing a mission-based financing approachA key benefit of mission oriented banks is that they are able to shape the direction of growthby making strategic investments across many different sectors and nurturing new industriallandscapes18.

The Bank should, therefore, adopt a wide cross-sectoral perspective on growth opportunities.The missions set for the Bank would provide a focus for its investment strategy, but notconstrain the Bank’s activity. The Bank should support innovative, high growth Scottish firmsin whatever sector they appear other than those activities that may cause reputational issuesor go against the principles of the Bank’s ethical investment code.

SG should be responsible for setting the missions for the Bank on a pre-determinedtimeframe and aligned to policy priorities. It is beyond the remit of this report to propose suchmissions, but examples based on existing Scottish economic policy might include:

● Transitioning to a low carbon economy, including decarbonisation of the transportnetwork

● Responding to emerging demographic pressures, including the twin challenges of anageing population and wider population health

● Promoting inclusive growth through place-making and local regeneration, including sitepreparation, infrastructure (transport and communication links) housing and relatedcommercial, education and health investment.

Complementary SG policies, regulation and alignment with the enterprise agencies will benecessary to achieve these missions and ensure there are viable firms and projects that canbe brought forward for financing by the Bank. Further benefit can be realised where there aresupply chain interdependencies and connections between and across relevantmissions/sectors which have the potential to be mutually reinforcing. An example of what amission-based finance approach could look like for the Bank is set out in Figure 5.

Figure 5: Case study – Transition to a low carbon economy: decarbonisation of the transport network

To illustrate the potentially transformative impact that mission-oriented finance could have on theScottish economy, it is helpful to use an example. Consider the SG’s mission to transition to a lowcarbon economy. To achieve this, a key priority will be decarbonising the transport network, includinga move to electric vehicles, where the SG has set an aim to phase out the sale of new petrol anddiesel vehicles by 2032.To achieve this, significant investment is required to finance the rollout of nationwide infrastructureand to support technology advances to enable such change. There are currently significantchallenges in the limited supply of vehicle charging points, underinvestment to date in the technologydevelopment required to ensure batteries are able to store energy for longer, as well as capacityissues with the current grid. Therefore, the investment required to support the economy transitionwould be in the form of nationwide vehicle charging infrastructure, technology development inenhanced battery storage, and increasing the capacity of the current grid system to enable longerenergy storage and increased energy mobility. There is therefore an opportunity for Scotland to bean innovation leader in low carbon technologies, including in technology development, manufacturingand supply chain capabilities, which will use these technologies and can in turn be exported.There are opportunities for the Bank to provide mission-oriented finance in the form of debt and/orequity in this context – from early, market shaping, cornerstone equity financing in infrastructure aspart of an SG coordinated infrastructure rollout programme (crowding-in private investors), toproviding patient growth and scale up capital to Scottish based companies developing technologysolutions and building capabilities to realise the large scale manufacturing and supply chainopportunities presented by the mission. SG will also need to help create the right conditions forinvestment to get the best from this market in terms of policy and regulation. There is an evidentopportunity for the Bank to play a pivotal role in achieving results in this rapidly developing market.

18 Mazzucato, M. and Macfarlane, L, (2017), “Patient strategic finance: opportunities for investment-led growth in theUK”. UCL Institute for Innovation and Public Purpose, Working Paper Series (IIPP 2017-05)www.ucl.ac.uk/bartlett/public-purpose/wp2017-05


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Initial activities of the BankThe broad role of the Bank should encompass growth capital and mission-based finance.

Growth capitalThe evidence of market failure and gaps outlined earlier in this section, and in the supportingevidence base, means the Bank will be directed to supporting companies’ growth ambitions,technology advancement, innovation and commercialisation, including those businesseswhich are driven by knowledge and ideas rather than operating with a strong base of fixedand tangible assets. The Bank should do this by providing access to long-term patient financenecessary for ambitious firms to invest in order to grow and turn their ideas into revenues,and also seek to address recognised gaps in the current market for lending to SMEs whoseneed for finance may be over a short to medium-term horizon.

There is evidently an opportunity for the Bank to take an innovative approach whendeveloping its financial products for the Scottish economy, for example, in trying to leverageadditional finance from the value of intangible assets. The Bank should also have theresource and capabilities to be able to advise companies to help structure complex deals toincrease the volume of successful finance raising activity in Scotland, recognising that thereis a need to stimulate greater demand for patient growth capital.

Two case studies are provided in Figure 6 and Figure 7 to illustrate the types of growthcapital products the Bank could make available to companies.

Figure 6: Case study – Renewable energy supply chain

A company developing new technology to improve the efficiency and lifespan of mechanicalcomponents in wind turbines has been funded to date by a combination of large R&D grants andearly stage equity, including co-investment through the Scottish Investment Bank. The company hassignificant domestic sales opportunities, as well as potential for export activity. To move the businessto the next stage of development (including developing a manufacturing base and funding a salespipeline) a financing package of £10m is required.The amount of support needed is beyond the scope of SIB’s core funds and a lack of asset backingmeans securing meaningful traditional debt would be challenging. A package of equity andpotentially mezzanine debt could be considered as a solution, involving suitable private sectorinvestment partners as appropriate. The clear links to the low carbon agenda as well as innovationand scale up activity, this type of business, allied to the financing requirement and the contribution tolikely missions, make this scenario a potential customer for the Bank, provided that the proposaladhered to prevailing risk parameters.

Figure 7: Case study – SME food and drink business

A family owned SME business with turnover of c£10m is looking to improve its manufacturingfacilities to take on new contracts with large retailers and thereafter expansion into new overseasmarkets. Currently employing 35 people in a semi-rural location, with the expectation of adding afurther 10 permanent jobs if the works on the manufacturing improvements go ahead. The plannedimprovements would involve the purchase of bespoke machinery and improvement to the fabric ofthe existing factory and would involve total expenditure of around £1.75m. The company cancontribute £500k from cash reserves and its existing bank is prepared to provide a loan of £750k inaddition to existing working capital facilities. However, due to the bank’s view on asset cover thereremains a gap of £500k in the financing package.As one of the potential areas of activity for the Bank is the provision of debt finance for SMEs toaddress identified market gaps this financing requirement, this scenario is a potential customer forthe Bank, provided that the proposal adhered to prevailing risk parameters. Any agreed financingwould probably be provided by way of subordinated/mezzanine debt sitting alongside existingbanking facilities.


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Mission-based financeThis would encompass the financing of infrastructure, projects and initiatives that will helptransform the economy. In doing so the Bank should support the government’s broader policyobjectives which, when combined with the appropriate regulatory and other levers, will createnew markets for the Bank to finance. To achieve this transformative, mission-based remit ofthe Bank, there will be a need for investment in projects that will help Scotland exploit andaccelerate innovations to meet new economic opportunities and societal challenges.

Clear activities for the Bank are to firstly provide viable companies with finance, where otherinvestors will not invest, to commercialise the innovation and technologies, and secondly toprovide finance for investment in new technologies and innovation that can contribute to themarket making and acceleration of an economic opportunity. This is with a view to providingmarket confidence to accelerate the crowding in of private capital. This should create theenvironment to allow the Bank to consider full or partial exits from transactions once themarket is fully established, other investors’ confidence has grown or a new technologicalinnovation has been proven.

Financial productsThe initial product range that the Bank should focus on is:

Growth capital

● Provide SMEs with access to micro loan finance of up to £100K by the continuation ofthe existing activities enabled by SG’s SME Holding Fund

● Expand the offerings of loan finance to SMEs by providing short to medium-term loanfinance (senior and mezzanine debt) in the range between £100K and up to £1m-£2mfor which there is current unsatisfied demand

● Consider the potential to deliver targeted debt support through the creation of specificloan funds. An example of this being the recently launched Brexit Loan Fund to beestablished by the Strategic Banking Corporation of Ireland. This fund has an initialvalue of €300m and will be available to both SMEs and small Midcap companies whoare already being or are expected to be impacted by Brexit, particularly in relation toexport activity

● Provide early stage risk capital equity up to £2m currently provided by the ScottishInvestment Bank via its co-investment funds

● Provide other targeted equity and mezzanine investment models for amounts up to £2m,whilst also providing scale-up investment finance by way of equity and loans up to £10m,and above, where opportunities are identified.

Mission-based finance

● Finance could be both debt and equity depending on the analysis of the gap or marketopportunity, but focused on the transformative change agenda set by the Programme forGovernment

● The initial area of focus recommended for the Bank is to develop products to support thetransition to a low carbon economy, including infrastructure where financing can bescarce

● The Bank should also offer investment products that support mission-based investment(equity and debt) that enable and accelerate, at scale, place-making developmentactivities, including housing development, regeneration and new business infrastructureand premises.


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Appendix B sets out in broad terms the types of financial products the Bank could offer.

In bringing clarity to the scope of the Bank, it is also helpful to outline those activities that itshould not engage in. These include the following, which are excluded due to aninappropriate fit with the Bank’s remit and/or for operation reasons:

● The Bank will not take deposits, offer mortgages or other traditional banking productsand services. As such the Bank does not need a network of branches

● The Bank should not undertake funding activities, such as the awarding of capital andrevenue grants which are the remit of SG and its enterprise agencies. Instead, its focusshould remain on financing activity, with any monies advanced must be repaid and be oncommercial terms.

The existing public sector investment landscapeScotland has well-established public sector support providing funding and financing adviceand the provision of funding and financing directly or indirectly to companies seeking to grow,including Scottish Enterprise’s Scottish Investment Bank, the Scottish Government’s SMEHolding Fund, the Scottish Growth Scheme and Scottish Futures Trust (“SFT”). SG has alsodeveloped several financing vehicles in response to market conditions and need particularlyin respect of housing and regeneration activity such as the SPRUCE Fund and theInfrastructure Investment Fund. Appendix C sets out further details of the current publicsector financing landscape considered as part of the development of the ImplementationPlan.

The report recommends that the new Bank should integrate existing financing activitiesprovided by SG and its agencies into its remit and operating model to build on the success ofoperations and initiatives underway, offering an opportunity to develop strengths and build onexisting skills and align complimentary activity.

This integration should help achieve clarity of purpose and cohesion across the public sectorfinancing landscape, simplifying the interaction with customers.

Scottish Futures Trust

SFT is an organisation owned by, but operating at arms’ length from SG, with responsibilityfor structuring and delivering important infrastructure programmes and innovating to securenew ways of funding essential infrastructure. SFT works collaboratively with public andprivate sector bodies to achieve more operationally and financially effective publicinfrastructure, working on the investment planning, design, financing, delivery, efficient useand disposal of assets across Scotland.

The infrastructure delivery programmes led by SFT support the delivery of publicly fundedinfrastructure assets (including schools, hospitals and roads) paid for out of general taxation.SFT does not act as a source of finance or investment in the delivery of infrastructure, exceptvia its wholly owned subsidiary Scottish Futures Trust Investments Limited (“SFTi”). Thissubsidiary invests relatively small sums19 on behalf of SG in specific infrastructurecompanies, assets and projects across Scotland to support the particular commercialstructures where infrastructure is being delivered by programmes that SFT is responsible for,such as, subordinated debt into Design, Build, Finance and Maintain (“DBFM”) projects in thehub programme.

19 As at 31 March 2017, SFTi had invested £13.6m into 31 separate hub projects.


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The Bank will be a key stakeholder for SFT to work collaboratively alongside, to ensure thatthe objectives of SG in delivering value for money infrastructure investment are achieved in ajoined-up manner by both organisations, albeit operating with separate and distinct remits.Where SFT currently provides advisory support to the public sector in respect of the financingof specific government initiatives, such as low carbon infrastructure (e.g., via the ScottishEnergy Efficiency Programme), it is anticipated that SFT would also work with and alongsidethe Bank to assess the financing need/opportunity for the Bank in supporting suchprogrammes.

British Business Bank

The BBB is a UK Government owned business development bank dedicated to makingfinance markets work better for small and medium businesses. It has a UK wide mandate.The BBB offers support to delivery partners at a range of levels, by providing the capitalrequired to start a business, grow it to the next level or stay ahead of the competition byproviding a greater volume and choice of finance.

The Bank should seek to encourage and facilitate BBB investment in support of SG aims,and its own activities should complement and be aligned with the activities of the BBB toensure Scottish businesses benefit from the most effective mix of support mechanismspossible. Where there is the potential for overlap the Bank should take the lead inestablishing the strategy for alignment.

UK Export Finance

Export finance is a crucial component of the financing landscape, particularly for innovativecompanies who need to get their products to as wide a market as possible in a short period oftime to profit from their innovation and market leadership. Growing firms and firms that arerich in intellectual property, but poor in traditional, physical assets, can find it difficult tosupport the bond requirements that often come with exporting, and can also find workingcapital requirements stretched as their balance sheets are used for necessary bond andinsurance products.

UK Export Finance (“UKEF”) has over the past few years greatly expanded its support forsmaller firms in the UK, including in Scotland, and has launched a number of new productsaimed at supporting exports. However, it is vital that Scottish exporters have at least asstrong support as firms in the rest of the UK, and while export finance will not form part of itsinitial set of products, the Bank should maintain a watching brief on the export finance marketin Scotland and develop interventions if they prove to be necessary.

Investment strategyThe investment and financing market in Scotland currently provides financing across a rangeof investment products, from early stage and venture capital, to scale-up growth capital andsenior, mezzanine and subordinated debt. The Bank should provide economic benefit byaugmenting this existing market and where appropriate taking a lead on new financingrequirements to catalyse activity from existing market players.

In order to do this, the Bank should focus on financing firms whose needs for capital areinadequately serviced by the market, either because the market feels it is unable to managethe level of risk as part of investors’ remit in more conventional portfolios or because thetimescales required for the return to be realised are longer than conventional investors canaccept. For example, banks which are constrained by regulatory capital rules and funds withrequirements to pay investors in a certain timescale can be averse to illiquid assets thatrequire an unknown exit event for the return to be realised.

By investing or lending differently, and by adopting a potentially alternative appetite for riskand the liquidity of investments, a new and valuable approach to financing can be introducedto the Scottish financing market although in doing so the Bank will adopt a commercial basisfor its investments.


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The Bank should become an enduring institution whose impact continues to grow over time.In order to achieve this, the key principles that should guide the Bank’s Investment Strategyshould cover:

Key principles

• The Bank should seek to ultimately develop into a self-sustaining institution. It is estimated thatthis could take 10 to 15 years from inception.

• The Bank should increase the impact of its interventions by crowding-in private finance,developing new markets and growing the economy. Leveraging in private capital alongside itsown investments can happen through co-investment or through an asset management structurewhere the Bank and the private sector agree on a specific investment mandate.

• The Bank should act wholly commercially in taking decisions based on the viability of the firms orprojects in which it invests (either by itself or with others) and the expectation that it will generatepositive returns from all of its investments. In some cases it will invest on full commercial termsand taking the same returns as the private sector. In other areas (e.g., where State Aid rulesallow, in response to specific market failures) it may be appropriate to take different risks ordifferent returns to the private sector, but always in expectation of a commercial return.

• The Bank should also take into account economic, social and environmental returns whenmaking its investment decisions. A balanced scorecard will be developed between the Bank andSG to establish the requirement and measurement of non-financial returns.

• The Bank should look to maximise impact by catalysing activity that otherwise would not happen.This would most effectively be achieved by placing the Bank at the centre of the investmentprocess, nurturing knowledge and expertise, coordinating other stakeholders in the investmentecosystem and acting as investor of first resort – not just investor of last resort.

• The Bank should invest at different levels of risk in different areas, and potentially take risks theprivate sector does not currently have the appetite for without public intervention, or does nothave the appetite for in sufficient scale to meet the need. As time progresses, private capitalshould enter markets once evidence around risks of particular investments is better known andevidenced, such as commercialisation risk for a new technology.

• The Bank should spread its actions across different types of investment activity to achieve abalanced portfolio and generate sufficient returns to enable it to be self-sustaining. This meansthat the Bank’s activity will be in a range of areas at different levels of risk and over a different setof timeframes.

• The Bank should have a national mandate to realise benefits of investment at scale, whilemaintaining regional reach to help businesses to realise their full economic potential acrossScotland. This will be particularly important since Scotland’s productivity challenges varysignificantly across regions.

• The Bank should be open to investing differently to existing available private finance marketsshould be central to the remit of the Bank, with freedom from regulatory capital constraints beinga key differentiator for the Bank in how it assesses opportunities.

• The Bank should invest ethically, developing and implementing its own ethical code forinvestment.

It is for the Bank’s Executive Management Team to develop a detailed investment strategyand the specific financial products required to deliver the Bank’s investment objectives. Weanticipate that those objectives will change over time to meet evolving market circumstances,and the Bank should have capacity to follow gaps in the market as they emerge/dissipate.


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Crowding in private capitalThe Executive Management Team should ensure private capital is crowded-in whereverpossible. Public sector ‘first loss’ positions are not attractive as not only can they result inpoor investment returns, but also misalign incentives that can result in a lower qualityinvestment strategy overall.

There are examples of successful interventions which have brought in private funding,including the co-investment activity taking place through the SIB which has leveragedsignificant private capital and the UK Government’s Enterprise Capital Funds. The success inearly stage equity markets provides confidence that Scotland can repeat this in other areasled by the Bank.

The work that the Bank can do in helping to innovate and structure deals, especially wherethe Bank acts as a cornerstone investor in transformative projects, will be instrumental inenabling a wider range of private capital to invest in projects and programmes they would notnormally be able to access. It can be that institutional investors such as pension funds whomay wish to invest in an asset class (such as infrastructure) can lack the capability to accessthose opportunities. The Bank should seek to catalyse this investment and help to bring inthose potential providers of finance.

Intangible assetsTo reflect the trends within a modern, dynamic and knowledge-driven economy, the Bankshould also look at ways to improve the market for finance through leveraging IntellectualProperty and intangible asset valuations. By intangible assets, we refer to intellectualproperty, patents and skills which cannot be easily valued, and are often illiquid.

Many innovative companies are intangible-rich, but tangible asset poor, meaning thattraditional lending and investment methodologies fail to recognise the value of the companyand finance is hard to access. In this context the Bank could investigate creating a systemaround valuation of intangibles to provide collateral to lend against. While many privateinstitutions are interested in the valuation of intangibles, the ability of a NIB to co-ordinate andstimulate the use of a potential system or standard could be invaluable to companies seekingfinance.

Consultation feedbackRespondents to the consultation process noted that in order to support economic growth, anaddition to the financing landscape, which took a different approach, was necessary. Manyfinance providers were thought to be too short-term and unable to properly support growth.There was criticism of the current market situation and respondents felt that the Bank shouldprovide additional support for Scotland’s small and medium sized enterprises and be able tobe a source of patient capital enabling firms to grow.

Many respondents wanted to ensure that the Bank’s efforts were focused on providingservices for which there was a gap in the market and where failures meant that finance wasnot available, rather than replicating currently available offerings. There was a strongresponse to indicate that there are market failures in the provision of finance, particularly inearly and growth stages. Opinions varied as to the exact shape of the financing gap – somerespondents focused on sub-£1m funding, others that larger sums up to £10m should be thefocus.

In addition, many respondents also felt that simply providing finance was not enough. In orderto secure the sort of transformational change that is aspired to, a large number ofrespondents wished to see further support, in order to help bring forward projects andbusinesses who might otherwise be locked out of further financing as a result of a lack ofcommercial awareness or business planning expertise.


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SummaryThe Bank should support the following areas of activity:

● Growth capital – providing strategic and patient capital at early and growth stages offirms’ development so that they are able to accelerate innovation and make a strongercontribution to the Scottish economy

● Financing infrastructure, projects and initiatives that will transform the economy,supporting the missions developed by SG.

These investments should come through a variety of instruments, including debt, equity andmezzanine finance, to suit the risk profile of the underlying investment. Over time, the Bankshould be able to reinvest capital and the management team should be able to develop aportfolio that balances the risk of the various investments and the timeframes of expectedreturns.

The Bank should build on the success of existing public sector financing operations utilisingthe skills and knowledge available, given the clear alignment with the Bank’s agenda. Themost significant is Scottish Enterprise’s SIB and SG’s SME Holding Fund and the ScottishGrowth Scheme. This will also ensure that the new Bank will simplify, not complicate, theexisting financing landscape creating a coherent setting for those firms looking for finance.

The Bank should operate under a clear set of commercial principles aiming to make apositive return on individual investments and over the long-term at a portfolio level andbecome a self-sustaining institution. It should also commit to maximise additionality to thecurrent market and improve the financing landscape for Scottish firms.


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RecommendationsRecommendation 3: This new, mission-led institution will actively create and shape markets.It will intervene in a variety of areas – to supporting early stage and smaller firms and largerscale innovative projects get access to investment, through to financing infrastructure wherethe private sector will not invest. The initial focus of the Bank should be:

● Providing growth capital to ambitious and innovative companies – with the capability tosupport across the lifecycle of a company’s need for capital

● Providing finance to support the projects and initiatives aimed at realising opportunitiesto transform the economy.

The Implementation Plan sets out a range of financial products that the Bank should seek todevelop to support this initial focus.

Recommendation 4: In addition to the supply of capital, the Bank should coordinate with otherentities seeking to stimulate demand for financing. In financing transformational projects, theBank will need financial structuring and complex transactional skills and consequently anelement of demand stimulation will be required in this area, working closely with theenterprise agencies who provide a range of support services to companies, and with theScottish Futures Trust in relation to its activities on infrastructure.

Recommendation 5: The Bank should aim to focus on, and give priority to, areas ofinvestment that are additional to the finance already provided by the market and by otherproviders in Scotland, complementing rather than crowding-out existing or potentialinvestment.

Recommendation 6: The Bank should adopt a balanced portfolio approach across a range ofpotential products and asset types. Its target should be to achieve a positive financial returnon its individual investments, and at a portfolio level which should be measured over at leasta 10-15 year horizon, recognising the focus on investment in patient capital andtransformative infrastructure.

Recommendation 7: Scottish Ministers should determine an appropriate basis for measuringthe Bank’s performance, taking into account the long-term nature of the investments andmission-orientated approach that’s envisaged for the Bank. A balanced scorecard approachis required that reports on the financial performance as well as on economic impact overtime, including social, environmental and ethical returns.

Recommendation 8: The Bank should seek to maximise leverage of private capital asappropriate, alongside its own investments. In doing so, it should adopt a flexible approach; itmay be appropriate for the Bank to invest or lend directly alongside private sector investorsthrough third party delivery agents or via external funds.

Recommendation 9: The Bank should build on current skills and experience successfullydeveloped in Scotland, building on the track record of success, and creating a single point ofdelivery of financing support for business growth and innovation financing for transformationalprojects.

A detailed review will be required in response to this recommendation in order to achieve theoptimal operating model and ensure essential close interaction between the Bank and theenterprise agencies, including how to ensure co-ordination of funding, company relationshipsand financial readiness activities that will be provided by the agencies.

Recommendation 10: The Bank’s activities should be aligned with the activities of the BritishBusiness Bank in Scotland, which may require establishing a strategy for alignment betweenboth institutions.

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3Classification and capitalisation of the Bank

Classification and capitalisation of the Bank

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The issues of classification and capitalisation are linked. The Bank’s classification status inthe National Accounts, a decision formally made by the Office for National Statistics, isdetermined by the level and form of control exercised by Ministers. This has implications forthe Bank’s operational arrangements, initial and future capitalisation, funding requirementsand treatment in the National Accounts.

Structure of the Bank

In developing the recommendation for the structure of the Bank, the following issues wereexplored:

● Ownership – establishing the Bank as a public or private sector institution

● Regulation – specifically the need to apply for a banking licence

● Form – the appropriate corporate structure for the Bank.

There are a wide variety of potential structures for the Bank. While there are some examplesof private sector institutions that work in partnership with governments to meet policyobjectives, such as the Business Growth Fund in the UK, the expectations of return and typesof risk that the private sector is prepared to take are a barrier to a private sector body beingable to carry out the range of investments envisioned for the Bank. Given this the Bankshould be part of the public sector, though part of its remit should be to leverage in privatecapital at the level of investments or funds.

Many of the investments that the Bank will make will be through equity, or equity-likeinstruments. This means that it will not be a bank in the traditional sense of a financialinstitution that loans money and manages the credit risk on those loans. As well as credit risk,banks manage the maturity risk between the money they lend and their funding; for thisreason they are regulated in terms of the equity (regulatory capital) and the liquidity risk theybear. This structure would therefore not suit the remit of the Bank as it seeks to be as flexibleas possible in the nature of its financing support, and nor would it aim to take deposits. TheBank would act across different types of investment and therefore an asset managementstructure would be appropriate. As such, it was concluded that the Bank would not require abanking licence.

In order to establish a corporate body to manage assets, SG could set-up a statutory non-departmental public body. However, this process and structure could be complex, would notbe an ideal fit for a financial institution, and would not add anything to what could be achievedthrough a company structure. Therefore, the proposition is that the Bank should be formed asa limited company owned by Scottish Ministers. For the Bank to operate in the wayenvisaged and set out in this report, it must have a separate legal personality and the abilityto establish subsidiaries with specific purposes for investment and fund management in orderto meet regulatory obligations.


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ClassificationTo ensure the sustained alignment of the Bank to national economic policy, Scottish Ministerswill need to set the strategic direction of the Bank. This means that, as discussed above, theBank will be classified as a public body. In order for the Bank to have the desired impact it willalso require:

● Administrative and operational independence. This will provide assurance to externalstakeholders and other investors that it will operate on a commercial basis in thoseareas that align with SG’s strategic direction

● The flexibility to mix products to be offered and operate in different market areas,adapting to changing market conditions as necessary

● The ability to attract staff through appropriate terms and conditions with the right mix ofskills and experience for successful delivery of the Bank’s mandate (including personnelwith banking and investment backgrounds).

As a supplier of patient capital with an investment horizon of 10-15 years, the Bank willrequire public capital and budget support from SG for upwards of 10 years, both to run theBank and meet its operating costs, as well as capital for making investments. This means thetimeline for any recycling of capital would be longer than most other private investments.

CapitalisationIn time, the aim for the Bank should be to make a positive financial return and become self-sustaining. However, it will require capitalisation from SG to commence activities. An earlycommitment to this has been made by SG in the 2018-19 Draft Budget with an undertaking toprovide initial capital of £340m over 2019-20 and 2020-21.

The Draft Budget also announced establishing a new £150m Building Scotland Fund (£80min 2018-19 and £70m 2019-20) to increase housebuilding, commercial property and R&D. Itis proposed that any investments entered into by this Fund and any pipeline investments andremaining balance on the Fund transfers to the Bank for its shadow year of operation in2019-20.

The proposed target level of initial public capital for the Bank from SG is a minimum of £1bnover the first 5 years. A further £1bn target should be set for public capital in years 6-10. Thisscale of public capital is deemed to be of a level that will make a material difference to thesupply of capital to the Scottish economy, balancing the need to capital with the availability ofresources that SG can allocate.

It is also consistent with other NIBs. Review of international comparators indicates the level ofpublic capitalisation typically ranges between 0.5% and 1.5% of GDP. In a Scottish context,£2bn broadly equates to 1.3% of GDP.

Non-Government sources of financeA key objective of the Bank will be to bring in other sources of capital to supplement theactivities of the Bank. Most successful NIBs area able to leverage initial public capital byissuing bonds – thereby increasing the amount of funds available for investment in theeconomy. The ability to leverage relatively small amounts of public capital into a significantsource of strategic and long-term finance is a key source of strength for NIBs around theworld.


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Over the longer term the Bank should also look to leverage its initial capital base, furtherstrengthening its investment capability. However, in its early years this option will not beimmediately available to the Bank, as it will take time to develop an investment portfolio andthe track record that is necessary to issue its own bonds. But this should be an objective toprovide the Bank with the full range of financing powers and flexibility that is required to playa major role in the economy in perpetuity. It is recognised that dispensation from HMTreasury would be required for the Bank to raise its own finance.

From the outset, however, the Bank should bring in private capital to advance its objectives atthe level of particular interventions where the investment criteria and expected returns areclear. This has been achieved successfully elsewhere, including in Scotland via SIB, whichhas leveraged significant private capital.

Milestone objectivesThe Bank should seek to reinvest its financial returns, both capital and interest, to create alasting, self-sustaining institution with increasing influence on the Scottish economy. Toachieve this, there are some key milestone objectives:

● To secure a dispensation from HM Treasury to have the flexibility to manage, retain andcarry-forward cash balances over financial year-ends

● To become self-funding over the medium-term that is; the Bank covers its operatingcosts from investment returns

● To be able to raise capital in its own right and no longer be reliant on capital advancesfrom SG to fund its investments.

Initial HM Treasury dispensation

Each year, SG must operate within the budget limits set for capital and revenue by theScottish Parliament. The money available for this comprises the budget settlement providedby the UK Government and the taxes raised within Scotland. This annuality of approachmeans that money must be spent in year; capital receipts, for example, have to be re-cycledinto other projects in the same year.

Under the Fiscal Framework there is some limited flexibility at SG level to carry forwardcapital and revenue balances from one financial year to another through the ScotlandReserve. At present, the Reserve is capped in aggregate at £700m and the maximum whichcan be drawn down during the financial year is limited to £350m, of which capital is limited to£100m.

SG should request dispensation from HM Treasury for the Bank to hold reserves and carrythese over between financial years, out with the existing limits set for SG.

Securing a different approach to management of year-end balances is not without precedent.HM Treasury agreed a different approach to the Green Investment Bank (prior to its recentprivatisation) and to BBB, which has an on-going dispensation over and above BEIS’ existingbudget to invest public capital into SMEs. A similar arrangement is in place for Scottishhousing associations, on a temporary basis, which are currently classified to the public sectorwhilst legislation is passed to reduce public sector control over these bodies and return themto a private classification. Without such dispensation the Bank would be unable to deliver thescale and ambition which is set out for it here, including through the adoption of a long-term,patient investment strategy.


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Resource costsAt this early stage, it is not possible to give a fully accurate assessment of the running costsof the Bank. Much of this will depend on the precise nature and timing of the investmentactivity of the Bank, and its operating model, and how it is able to work with third parties.However, an exercise was undertaken to look at comparable organisations and also built uppotential costs based on the activities set out in this plan. Costs would include staff, corporateadministration resources and systems for financial management and investment and riskmanagement.

The potential running costs for the Bank when fully established are estimated to be between£20m and £30m per annum. This would allow for an organisation that would have circa. 100to 150 people working for it and engaging in a full range of investment activities. This willallow the Bank to have the scale of effect on the Scottish economy that is desired.

The Bank should be set up as efficiently as possible, with many resources re-deployed intothe Bank where possible. In the first three years of the Bank’s operation, the costs would belower as the Bank expanded its activities and brings current finance activity on board.

SummaryThe initial capitalisation of the Bank will be from SG, and given the timescales that arerequired to invest ‘patient’ capital (whether debt or equity), support from the government willbe required for a number of years.

The Bank will be classified to the public sector (central government) when it is set up,although it will have operational independence from government. This means that in order forthe Bank to retain funds over the long term and reinvest in the Scottish economy, somedispensation from HM Treasury will be required to enable flexibility in the carry forward ofcash balances over financial year-ends.

A key objective will be for the Bank to leverage its initial capital base and raise its own bonds.It is recognised that dispensation from HM Treasury will be required for the bank to raise itsown finance.

RecommendationsRecommendation 11: The Bank should be established as a public body to ensure a continuedfocus on the Scottish economic strategy and alignment with a mission-based approach toinvestment. The form of public body should ensure maximum flexibility in how the Bankinvests.

Recommendation 12: Long term, mission-orientated investment requires a long-termcapitalisation and funding commitment by the Scottish Government. The target level of initialcapitalisation is £1bn for new activity, provided over the first five years followed by a further£1bn over years 6-10.

Recommendation 13: Three essential milestones should be set for implementation andsuccessful operation of the Bank at the scale envisaged:

● To be set-up with the flexibility to manage, retain and carry-forward cash balances overfinancial year-ends

● To become self-funding over the medium term that is; the Bank covers its operatingcosts from investment returns

● To be able to raise capital in its own right and no longer be reliant on capital advancesfrom the Scottish Government to fund its investments

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4Governance arrangements

Governance arrangements

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Establishing a framework for good governanceOperating on a commercial basis, to the highest investment management standards andoperationally independent of SG, the Bank will be in a position to make robust investmentdecisions without undue influence or control from SG. It is important that the day to daymanagement and operational activities be at arms’ length from SG.

The Bank should maintain its mission-led focus over the long-term, having the confidence tooperate in areas which the wider market tends not to consider and accepting a different riskprofile to other investors. This should be achieved by the Bank following the governingprinciples and arrangements described below:

● Scottish Ministers should be able to set, monitor and, where appropriate, amend theoverall missions for the Bank and the rules or parameters within which the Bank invests,and to fully understand the risk consequences and contingent liabilities which arise fromthe various missions undertaken by the Bank. SG should do this by establishing a fiveyear Strategic Framework for the Bank to work within

● The Bank should develop its Investment Strategy and Business Plan in response to theStrategic Framework – establishing its priorities within the framework and retainingdiscretion about what it invests in, when investments should be made and the natureand value of investments. The Investment Strategy should align with the five year periodof the Strategic Framework, whilst the Business Plan will be developed and updatedannually

● The Bank’s Board will be fully responsible and accountable for the approach taken todelivering its missions

● The Bank should be operationally and administratively independent of SG

● There should be clear reporting and accountability of performance and outcomes, whichis supported by an appropriate remuneration framework which promotes and ensuresrobust risk conforming and independent behaviour by the management of the Bank

● Given its expected mandate from Scottish Ministers, the potential for the Bank to investwith and on behalf of third parties, and the high level of external scrutiny which the Bankis likely to face, it must operate to very high standards of risk management, regulatorycompliance and transparency.

The overall nature of the relationship to SG and the governance arrangements should bemade clear through the Bill needed to establish the Bank, which will include how the directionwill be set by Ministers. The Bill and its accompanying documents should detail therespective roles of Scottish Ministers, the Board and the Executive Management team, andthe formal reporting and accountability arrangements

The appointment of the Chair and Non-Executive Directors will be made by the ScottishMinisters, and the board will likely contain a minimum of two Executive Directors (ChiefExecutive Officer and Finance Director).


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Corporate structureThe legal structure proposed in Figure 8 reflects the target model suggested for the Bank,and the broad parameters proposed for its relationship with SG.

To ensure that the Bank remains aligned to SG’s economic strategy, it is envisaged that theBank should be a limited company with Scottish Ministers being the sole shareholder, for thereasons outlined previously. Some of the capabilities envisaged for the Bank include thesetting up of subsidiaries for co-investment activity, which should help ensure State Aidcompliance and secure appropriate State Aid and Regulatory approvals to carry out thedifferent functions, such as managing investments or making market investments.

As set out in Figure 8, there should be a ‘Top-co’ structure with subsidiaries underneath theparent institution to carry out specific functions and different types of investment activity. Thisenables appropriate regulatory and State Aid frameworks to be aligned to the functions whicheach of the subsidiaries are anticipated they will perform. The precise structure, however, willbe subject to the Board’s and Ministers’ views.

Figure 8: Example of ' Top-co ' model with different subsidiaries

The Executive Management Team should manage the day-to-day running of the Bank, withthe necessary responsibility and autonomy for implementing the Strategic Framework agreedby the Board with Ministers. This should include determining the relationship between the‘Top-co’ and other parts of the Bank, such as:

● Risk and Compliance: ensuring operation within the Bank’s regulatory framework andmanaging risk under the scrutiny of the Audit and Risk Committee and, potentially, AuditScotland

● Financial Management and Treasury: managing the Bank’s balance sheet and ensuringits on-going liquidity, including the management and direction of its budget allocation

● Investment: responsible for implementing the Bank’s investment strategy, for investmentrecommendations, for decision-making on lending and investing to the extent delegatedby the Investment Committee; and for investment execution

● Asset Management: responsible for managing the Bank’s range of investments andloans.


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The Bank’s risk culture should inform effective risk management. This should reflect theBank’s nature of a ‘promotional bank’ business model for which generating profit is not theprimary focus. It should also seek to establish a trading book which is inherently stable(insofar as the strategic investments linked to delivery of missions set for it, and its marketmaking role will allow).

The expected high public profile of the Bank, its role and position within wider Scottishsociety, its anticipated impact on the economy and its mission-orientated mandate allincrease the need for substantial transparency, regularity and probity in the way that the Bankoperates. It should expect to make much information routinely public, in recognition of thewider public interest in its activities whilst also protecting commercial confidentiality. Thisshould include, for example, information being made public about investment decisions,investment performance, organisational costs, staffing structures and remuneration levels.

Diversity and inclusivenessCompanies across all sectors with the most women on their Boards of Directors significantlyand consistently outperform those with no female representation – by 41% in terms of returnon equity and by 56% in terms of operating results20. The Bank should play a clear role inpromoting diversity and inclusiveness. Included within this there should be an expectationthat the Board and Executive Management Team are gender-balanced.

Different groups also face different constraints with regards to access to finance. Forexample, the ability to access finance has been highlighted by a quarter of women businessowners as a key challenge to them starting their own business, and evidence has shown thatwomen on average start their businesses with a third less capital than that of their malecounterparts21. The Bank should consider how it could play a role in addressing thischallenge.

To help inform the content of SG’s Strategic Framework, including the nature of the identifiedmissions for the Bank, SG should assess the optimal means of consulting withrepresentatives from stakeholders and wider civic society. This report recommendsestablishing an advisory group, with membership drawn from a cross section of externalstakeholders, to advise SG on setting the Strategic Framework and reviewing theperformance of the Bank against this framework. It is also proposed that the chair of thisadvisory group would have a place on the Bank’s Board as a non-executive director member.

SummaryThe Bank should be a limited company, wholly owned by SG. The Bank should beaccountable to the Scottish Ministers for its performance, and through them to the ScottishParliament. SG should have the ability to set and monitor the overall mission of the Bank.

The Bank should operate at arm’s length from SG, and it should be independent indetermining how to develop and market its products and in making investment decisions.

The governance structure of the Bank should have a clear distinction between the roles of theBoard (Executive Directors, Non-Executive Directors and Chair) and the ExecutiveManagement Team. The Bank will have subsidiaries that would be responsible for variousparts of its activities under the overall umbrella of the Bank. This will facilitate regulatory andState Aid clearance for those activities.

20 McKinsey (2010), Women Matter(https://www.asx.com.au/documents/media/2010_mckinsey_co_women_matter.pdf)21 The Federation of Small Businesses (2016), Woman in Enterprise: The Untapped Potential,(https://www.fsb.org.uk/docs/default-source/fsb-org-uk/fsb-women-in-enterprise-the-untapped-potentialfebc2bbb4fa86562a286ff0000dc48fe.pdf?sfvrsn=0&sfvrsn=0)


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The Bank should adopt a leadership role with regards to diversity and inclusiveness. Forexample, it should have gender balance across its Non-Executive Director Board membersand it should seek to engage with a broad range of external stakeholders.

RecommendationsRecommendation 14: As sole shareholder and sponsor of the Bank, Scottish Ministers willneed to set the parameters within which the Bank should work. To do this Ministers shouldset a five year Strategic Framework for the Bank to respond to in its Investment Strategy andBusiness Plan. The reporting framework should ensure the highest standards of transparencyand accountability.

Recommendation 15: The Bank should be administratively and operationally independent ofScottish Ministers. The Board should include a Chair and non-Executive members appointedby Scottish Ministers, and two Executive Directors in the shape of the Chief Executive Officerand Finance Director. There should be an appropriately experienced and professionalExecutive Management Team.

Recommendation 16: The Scottish Government should consider how best to consult withwider stakeholders on setting the Strategic Framework for the Bank to ensure that there isbroad engagement with civic society on how the Bank is operating. This report recommendsthat an advisory group should be established whose membership comprises representativesfrom stakeholders and wider civic society. The group should advise Ministers on the Bank’sStrategic Framework. The Chair of this advisory group could be on the main Bank Board as aNon-Executive Director.

Recommendation 17: The Bank should establish and operate to the highest standards oftransparency, accountability and management of risk. This should be reflected in thereporting and accountability arrangements to be put in place, and in the formal governancearrangements of the Bank.

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5Transition plan

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The process to establish the BankThe transition to a fully operational and independent Bank should start immediately. It shouldconstitute an on-going process as the organisation is able to increasingly act as anindependent and fully formed institution. Appendix D sets out the high level tasks required toestablish the Bank and expand the range of its activity over time, with an initial target of ashadow year of operations in 2019-20.

Many of the required steps, such as engagement with State Aid and regulatory authorities,will involve an extended process that the Board and Executive Management Team will needto navigate to enable the Bank to commence activity and expand the range of its activity andshould therefore be initiated as soon as possible to avoid delays as the organisationdevelops.

An important process is transitioning, integrating and building on the current public sectorfinancing elements.

SG should use its existing powers and operations to begin to undertake some of theinvestment activity that will be part of the Bank in order to show progress and begin to buildthe portfolio of investments for the Bank. An important element will be to ensure coherencefor firms looking for finance in Scotland, helping them see a difference in the strength of theoffer.

Many of the activities set out below will be taken forward concurrently, so that by 2020-21 theBank is able to start its activity as a fully independent and effective organisation. The keyworkstreams are:

● Legislation and corporate structure – drafting and passing considerations, includingsetting up of relevant companies

● Budgetary – capitalisation, including any dispensation from HM Treasury, and resourcebudget for the Bank

● Senior appointments – appointments of the shadow Chair, and Board and ExecutiveManagement of the Bank

● Business planning and internal governance

● State Aid and regulatory clearance.

Some of the key points in the set-up of the Bank and interdependencies are set out below.

The legislative process and formal set-upPrimary legislation is required to enable SG to formally establish the Bank. It is anticipatedthat this process could take 18 to 24 months, and should therefore be commenced duringearly 2018 to allow for sufficient time for the Bank to undertake activity in its own right by2020-21.

While some shadow bank activity can take place prior to the completion of the legislativeprocess, the Bank will only have a properly independent existence (including entering intocontracts in its own right including the direct employment of staff or appointment of a formalBoard) once the legislative process is completed.

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Scottish Ministers will set the direction for the Bank and highlight missions that it shouldundertake. Initial drafting of an interim Strategic Framework should commence early toenable the interim Executive Management to develop an initial Business Plan that respondsto the direction set by SG during the establishment and transition stage of development sothat the Bank can operate in shadow form during 2019-20.

In order to achieve the operational independence envisaged and to be able to access privatecapital in due course, the Bank should be an independent legal entity. It is proposed that theBank will adopt a Top-co structure with subsidiaries carrying out certain distinct functions.This enables these subsidiary entities to have the appropriate regulatory and State Aidframeworks for the functions they are performing, as well as ensuring State Aid compliance.

Management of the transitionThe first stage in the transition should be the forming of a Project Team, including a projectbudget from SG, and a shadow Chair to deliver the transition. The project team and shadowChair should be in place by Q2 2018.

An interim Executive Management Team would be established to oversee the activities toestablish the Bank, transition of existing operations, development of appropriate corporategovernance and operational structures, and commencement of new activities under theBank’s remit in due course. These appointment should be made by Q4 2018, in advance ofthe shadow year of operations in 2019-20.

Formal appointmentsOnce the Bank is fully established with its own independent legal existence, a permanentChair, full Board and permanent Executive Management Team would need to be appointedthrough an appropriate process. The Board should establish appropriate Committees togovern the Bank’s activities. Executive Management will be responsible for putting in placeeffective risk assessment and investment processes and procedures. The Bank will likely besubject to the normal requirements of all public bodies (for example the Scottish PublicFinance Manual) and will need to take account of such requirements in its internal policiesand procedures.

An Executive Management team, will be led by the Chief Executive and will manage the day-to-day running of the Bank independent of SG. The Management Team should beestablished to ensure that it can cover the following four main functions within the Bank:

● Risk and compliance

● Financial management and treasury

● Investment

● Asset management.

Business PlanPreparation of an initial Strategic Framework and missions should commence early, to enablethe interim Management Team to develop an initial Investment Strategy and Business Planthat responds to the strategic direction set by SG in the Strategic Framework.

34

The key task of the interim Management Team would be to develop a business plan that setsout how the different functions described above would be developed in the Bank, whatinvestment activity it would undertake in its first years of operation, and how it would developa balanced portfolio of investments that represents an addition to the Scottish financinglandscape. This plan should also include the institutional development of the Bank and fit withthe legislative process in setting out how the relationship with SG will work. It should be aliving document that will develop as the Bank comes into being, gaining in complexity anddepth as time goes on and more clarity is available to the Bank as to the appropriate natureof systems, etc.

While it will not necessarily be used as part of a formal regulatory clearance process in thefirst instance, best practice indicates what the Business Plan should cover – the keycomponents of the Business Plan are set out within Appendix E.

Obtaining Financial Conduct Authority complianceThe Bank will need to demonstrate to the relevant authorities that it maintains high standardsof governance in its management, as well as having the operational capabilities andinfrastructure to deliver the proposed suite of products. If the Bank is established as an AssetManagement firm it will be regulated by the Financial Conduct Authority (“FCA”) prior toconducting any regulated activities. The FCA’s primary objective is to protect consumers,enhance market integrity and promote competition.

While it is unlikely that in the first instance the Bank would need FCA approval (though thismay be necessary soon after the Bank’s set-up). The set of issues that the Bank needs toaddress should be the basis of the Business Plan that the management of the Bank will betasked with developing, to ensure once activity commences, the Bank is capable of properlyundertaking its activities and making investments.

As part of the compliance process, the Bank will have to demonstrate adequacy of capitaland liquid resources, and develop contingency plans for recovery, resolution and businesscontinuity.

State Aid clearancesIt is anticipated that the Bank will be classified as a National Promotional Bank (“NPB”) by theEuropean Commission (“the Commission”) for the purposes of State Aid. The Commissionhas set out guidelines for the activities of NPBs and outline the process for the Commissionto approve the Bank. This is necessary to allow the Bank to commence activity in its ownright as a formal independent organisation, but does not change the latitude given fordifferent interventions, which remains the same for current member states. The Bank, isexpected to be able to act through the General Block Exemption Regulation (“GBER”) for riskcapital, the Market Economy Operator Test (“MEOP”), and any schemes specifically notifiedto the Commission.

It is recognised that Brexit has created uncertainty in this area. The process to look at StateAid should be started by the Project Team as an early action, so that it does not become ablock to speedy progress. The summary timeline, included in Appendix D, plans for up to 18months for this process to be completed.

Recruitment of staffThe Bank needs to be highly professional and operate with very high standards ofcompliance and conduct. The Bank must be able to attract the right expertise into itsmanagement and delivery teams, given it will be competing for specialist staff with the privatesector.

35

As well as financial and investment expertise, the Bank should aim to recruit or have accessto a range of staff from other disciplines and specialisms, such as economists, statisticians,construction, engineering and scientific sectors. This is both to support its management andgovernance functions and to ensure there is sufficient knowledge of the sectors in which theBank is likely to be actively investing22.

The culture of the organisation needs to be expert and professional in terms of operating inthe financial markets, attracting appropriate, high quality individuals and ensuring very highstandards of compliance and conduct. There will need to be a cultural balance struckbetween the organisation having a focus on delivering against stated public policy objectives,retaining focus on the mission, and attracting investment professionals with the appropriateskill and expertise.

SummaryThe Transition Plan will be comprised of a series of workstreams required to complete theset-up of the Bank. These include: legislation, recruitment of an interim ExecutiveManagement Team, regulatory and State Aid compliance, further recruitment and alignmentof relevant organisations. A key part of this will be the development of a detailed BusinessPlan by the management of the Bank.

RecommendationsRecommendation 18: In setting up the Bank, Ministers should appoint an independentshadow Chair as soon as possible, to oversee the work of a project team responsible for thetransition and set-up of the Bank. A shadow Board and interim Management Team should beput in place prior to the Bank operating in shadow form in 2019.

Recommendation 19: Scottish Ministers should concurrently confirm the Bank’s initialmissions and the first Strategic Framework, ensuring that the essential clearances andchanges required are obtained from HM Treasury and others.

Recommendation 20: The Bank will need staff with the right mix of skills and experience toensure its success and sustainability. The Scottish Government should ensure that the Bankcan offer employment and remuneration terms which are sufficiently competitive to attractsuitably skilled and experienced people.

Recommendation 21: The Bank should adopt a leadership role with regards to diversity andinclusiveness within its governance, operational arrangements and investment strategy.

22 Macfarlane, L. and Mazzucato, M. (2018), “State investment banks and patient finance: An internationalcomparison”, UCL Institute for Innovation and Public Purpose Working Paper, IIPP-WP 2018-01

37

Appendices

Terms of reference

38

Appendix A Terms of reference

In September 2017, SG announced within the Programme for Government that it would beginwork to establish a Scottish National Investment Bank. The First Minister subsequently askedBenny Higgins, the CEO of Tesco Bank, to lead the work on developing the Bank’s remit,governance, operating model and approach to managing financial risk. Mr Higgins convenedan Advisory Group of experts to support him in the development of this plan. In addition to thesupport from Scottish Government staff, membership consists of the following individuals:

● Paul Brewer (Former Corporate Finance Partner, PwC LLP)

● Paul Lewis (Interim Chief Executive, Scottish Enterprise)

● Professor Mariana Mazzucato (Director of the Institute for Innovation & Public Purpose,University College London)

● Alan McFarlane (Senior Partner, Dundas Global Investors)

● Peter Reekie (Chief Executive of Scottish Futures Trust)

● Liz Ditchburn (Director General Economy, Scottish Government)

● Alyson Stafford (Director General Scottish Exchequer, Scottish Government)

● Gary Gillespie (Chief Economist, Scottish Government).

This Implementation Plan describes the conclusions reached by Mr Higgins and the AdvisoryGroup and makes recommendations about how SG should proceed with establishing andcapitalising the Bank, what the Bank’s functions and structures should be, the relationshipthat the Bank should have with SG and existing financing agencies and interventions.

In addition to a commitment to establish the Bank last September, the First Minister set outTerms of Reference for the development of this Plan to guide the work of the Advisory Groupand the Outline Business Case which accompanies this report.

The Terms of Reference are set out below, including the Implementation Plan sectionreference to ease cross reference of key sections.

Terms of Reference Implementation Plan Section Reference

Evidence of market failure and business case

The implementation plan will be underpinned byanalysis of the evidence on market failures, andappraisal of potential solutions to ensure that thebank has the maximum impact on the Scottisheconomy. In particular this should set out howdisplacement will be minimised and additionalitymaximised by the proposed approach. Thisshould consider the potential scope of the bankin the widest sense drawing on this to inform itsview on scope.

The need for a Scottish National InvestmentBank

The plan will be based on engagement with keystakeholders in finance, the wider businesscommunity and civic Scotland to gather views onthe merits of potential delivery models andapproaches and their likely effectiveness instimulating additional investment.

Initial focus for investment activities

Terms of reference

39


It will develop the aims and objectives for theScottish National Investment Bank, drawing onwork from the Council of Economic Advisers andelsewhere and seeking to maximise thecontribution to the long-term growth of theScottish economy. This will include whether theactivities of the bank should be focusedexclusively on the private sector or whether thereis also scope to secure value in delivering newapproaches to public sector financing.

The need for a Scottish National InvestmentBank

The final report should take a wide view ofmarket failure and consider how this can beaddressed by the bank, e.g., not just thequantum of business finance but also how thebank's scope of activities, and involvement bothdirect and indirect, might impact on improvingconditions attached to finance for bothbusinesses and infrastructure investment.


The final report should consider whether thebank should interact directly with business orthrough intermediaries. It should also considerthe market for finance should it be limited toSMEs, wider business or include the publicsector, in which case how would it complementexisting sources of public finance.


Governance

Propose a governance model for the SNIB toensure effective oversight and accountability inthe delivery of the aims and objectives, and inparticular ensure that the governance addressesthe relationship with Scottish Ministers and theScottish Parliament. Whether or not this is bestdelivered in the public or private sectors shouldbe considered as part of the plan.


Working with SG Finance, consider theimplications of the proposed governance modelfor National Accounts classification of the SNIBand consequently any questions that would needto be addressed with UK Government about itsoperation within budgetary rules.


Identify how the bank could operate within thecurrent rules setting out what it could do andwhat it could not do. Make a clear case as towhere any existing budgetary rules have theunintended consequence of forcing a NationalInvestment Bank to operate in a sub-optimalmanner and the advantages that could be gainedfrom any changes.


Consider how the SNIB would relate to existingbodies, initiatives and funding streams whichsupport infrastructure, business investment andinnovation, and if appropriate where these mightbe consolidated within the SNIB.

Fit with the existing public sector financinglandscape

Terms of reference

40


Operating model

Develop a Target Operating Model for the SNIBto support recruitment of appropriatelyexperienced staff and establishment of otheraspects of the SNIB operations.

Transition plan

As part of considering the Target OperatingModel, set out initial principles for the SNIB toensure robust management of financial risk.

Transition plan

Capitalisation

Drawing on discussion with SG Finance, thereport should propose a capitalisation plan overan appropriate number of years to allow the Bankto operate effectively.


Financial products

41

Appendix B Financial products

The risk and return profiles are considered below in the context of the Bank establishing abalanced portfolio.

Figure 9: Illustrative risk and return profile for financial products

These benchmarks can only be a guide. As the Bank develops its Business Plan and starts toinvest, its management should adapt its strategy to the requirements of the market and toadd value as well as making a return. In addition, while target returns can be established inthe short-term, the actual return will not be apparent for several years, although there will beindications of the performance of both debt and equity.

An explanation of each investment and the expected returns are detailed below.

Investmentclass

Expected returns

Early stageequity

Medium to long-term investment with return in the form of proceeds of selling theequity on exit.Overall return will be net of the Bank’s costs of running the equity investmentprogramme (eg, investment managers, commercial advisors) and the costs ofinvestment failure (as risk capital, failure risk for this investment category isrelatively high).Target return for each investment in the region of 30-50%, in order to generate anoverall blended target return for the investment class of 10%, being investmentreturns net of running and failure costs.The British Private Equity and Venture Capital Association (“BVCA”)benchmarking23 indicates an average range IRR of 9.8% from this investmentclass.

23 https://www.bvca.co.uk/Portals/0/Documents/Research/Industry%20Performance/2016-Performance-Measurement-Survey.pdf

Financial products

42

Investmentclass

Expected returns

Mezzaninefinance

Medium-term investment with return in the form of interest, and, often at the end ofthe term, repayment of the principal amount. Interest will either be capitalised orpaid in cash during the period of the loan, or a combination of both. A variableshare in the business upside may also be received through either an equity warrantor a profit/growth levy or redemption premium equating to a percentage of the loanamount.Overall return will be net of the Bank’s costs and the costs of investment failure(whilst mezzanine debt has priority over equity, it is subordinate to senior debt).The BBB identified a target return in the region of 8-20%24 may be appropriate.This would accommodate an overall blended target return for the investment classof 10%, being investment returns net of running and failure costs.

Venturecapital

Short to medium-term type of private equity, provided to small, early-stage,emerging firms that are deemed to have high growth potential or havedemonstrated high growth to date.Venture capital generally comes from venture fund managers, high net worthindividuals, investment banks and any other financial institutions. The early stagenature of these investments are often inherently risky which is reflected in the oftenhigh rates of return sought on investments. Levels of returns and losses are akin toearly stage equity outlined above.

Subordinateddebt

Short to medium-term investment with return in the form of interest and, often at theend of the term, repayment of the principal amount.Overall return will be net of the Bank’s costs and the costs of investment failure(has priority over equity, but is subordinate to senior debt).Coupon price will reflect the risk of each specific investment. Target return 10-15%to generate a blended target return of 10%, being investment returns net of runningand failure costs.

Senior debt Short to long-term investment with return in the form of interest and, more thanlikely a combination of regular and one off payments at the end of the term, torepay the original principal amount.Low margin investment, so risk tolerance is also low. The Bank would aim to limitany failures to around 2% to avoid the investment class making a loss overall.

24 https://british-business-bank.co.uk/wp-content/uploads/2015/03/Growth-loan-research-report-FINAL-VERSION.pdf

Existing sources of finance

43

Appendix C Existing sources of finance

Scottish GovernmentSME capitalThe Scottish Growth Scheme is a £500 million package of financial support backed by theScottish Government to help businesses grow. The Scheme currently has two elements: theScottish-European Co-investment Programme, providing a package of £200m investmentinto SMEs; and new and additional funding for the SME Holding Fund – a £25m expansionwhich will lead to £100m invested in SMEs.

The SME Holding Fund is a “Fund of Funds” initiative managed by the Scottish Government,financed by European Regional Development Fund, which addresses gaps in Scotland'sfinance sector for those SMEs with growth and export potential, by part-funding a number ofinvestment vehicles managed by appointed Delivery Agents. These DSL Business Financewhich provides up to £25,000 to micro businesses under the Scottish Microfinance Fund;Business Loans Scotland, a consortium of Scottish Local Authorities with an in-house FundManager, which provides loans of up to £100,000 to SMEs; and, Scottish Enterprise, throughits Scottish Co-investment Fund and its Scottish Venture Fund which provides early stageequity risk capital up to £2m and within a deal ceiling of £10m to SMEs with high growthpotential.

Housing and regeneration financingThe SPRUCE is the ‘brand name’ for the Scottish JESSICA Initiative (Joint European Supportfor Sustainable Investment in City Areas). It is an evergreen fund originally co-financed with£50m from SG and EU funds and managed by the EIB. Amber, a private sector fundmanager seek to secure investments aligned to an agreed investment strategy for whichthere is a mandate to 2021. The ethos of the strategy is to ensure that SPRUCE caneffectively contribute to and marry up with regeneration projects which are consistent withScottish Government objectives and locally driven policies right across Scotland. The fund isfocused on supporting revenue generating projects that support urban regeneration. Allinvestments have a requirement for the recipient to deliver community benefits.

The £40m Infrastructure Investment fund (2017-18) is intended to finance and enable sitepreparation, installation of essential services and unlock stalled locations so that additionalhousing can be built provides both debt and equity finance. As the Housing InfrastructureInvestment programme matures, an increasing focus is on growth areas and regenerationcommitments which are regional economic priorities within City Deal delivery plans.

In the private rented housing sector, Government guarantees, loan investments and PWLBborrowing consents are supporting successful and innovative private sector vehicles in thedelivery and scaling up of new house-building for affordable and market rent provision,unlocking key sites and attracting large scale private investment. As expansion progressestowards over 10,000 homes across these programmes, new investments are, whereverpossible, seeking to raise quality standards and demonstrate how increased social value canbe achieved from housing investment.

Home ownership support schemes provide equity financing to assist home-buying. £70m isavailable in 2017/18 for SG’s Open Market Shared Equity scheme (OMSE) to help up to1,700 first time buyers on low to moderate income; and £65m is available this year for theHelp to Buy (Scotland) Affordable New Build and Smaller Developers Schemes to help up to2,200 households.

Existing sources of finance

44

Scottish EnterpriseThe Scottish Investment Bank (SIB) is the investment arm of Scottish Enterprise. It fills anumber of the functions of other international National Investment Banks within Scotland butits scope and scale is significantly less than sought for the Scottish National InvestmentBank.

SIB’s remit is supporting the growth and development of Scotland’s early stage risk capitalmarket operating as a market gap funder. A key part of the remit is to generate positiveeconomic impact whilst investing on a commercial basis. SIB’s remit has expanded overrecent years, continuing the innovative, and now established, co-investment approach with anumber of new interventions delivered aimed at improving the opportunity for companies toaccess available funding. All interventions are designed to lever significant private sectorfunding. Current financial products provided by SIB includes:

Early stage capital (up to £2m)The Scottish Co-Investment Fund (SCF) and Scottish Venture Fund (SVF) – are equityco-investment funds, part-financed by the European Development Fund through the SMEHolding Fund, designed to stimulate early stage risk capital investment into high growthpotential Scottish companies across a range of sectors given the strong evidence of a longterm, systemic market gap constraining company and therefore economic growth. The fundsinvest up to £2m within a ceiling of £10m, are private sector investor led, catalysinginvestment into high risk opportunities by sharing the risks (and rewards) with investorswhere there is an investment gap in a deal.

Growth capital (£2m-£10m)The Scottish European Growth Co-investment Programme was developed to supportcompanies’ growth and scale up given the lack of available growth capital identified. Thisinnovative programme (the first to be developed in Europe) is a £200m mechanism, £50m ofcapital commitment from Scottish Enterprise (provided by Scottish Government under theScottish Growth Scheme) is matched £50m from the European Investment Fund and £100mof private sector capital from a range of UK and European Venture Capital Funds invested inby the European Investment Fund.

Sector supportThe Renewable Energy Investment Fund is delivered by the SIB on behalf of ScottishGovernment. This fund was created to support Scottish Government’s mission to increaseenergy delivered from renewable sources, reducing the costs of renewable energy andincreasing community ownership and development of renewable energy projects. The Fundinvests via equity and loans, the Scottish Investment Bank team curates and structurescomplex deals supporting the development of a new funding market under ScottishGovernment’s low carbon policy agenda. This Fund transitioning during 2018/19 into a widerfocused Energy Investment Fund.

SIB invested £5m alongside a range of other Limited Partners into a £50m life sciences fundbased in Scotland, Epidarex LLP, to stimulate higher levels of early stage funding to one ofScotland’s key sectors. This fund invests in and promotes the commercialisation of ground-breaking research and new technologies to address large and unmet needs in today’shealthcare market.

Debt financeThe SIB provides financing of up to £2.75m through an innovative funding model to stimulategrowth in a Scottish based Peer 2 Peer lender, the Lending Crowd, adding to diversity andchoice for companies struggling to raise debt.

Transition plan summary timeline

45

Appendix D Transition plan summary timeline

Business plan contents

46

Appendix E Business plan contents

The table below identifies and describes the key sections of the Business Plan.

Sections and components

State Aid andregulatoryclearance

• Progress on State Aid Clearance for market activities.• Progress on regulatory clearance – work through necessary asset

clearance with Financial Conduct Authority with the FCA.

Operating modeland legal entity

• Building on work by the Scottish Government, further work on the Bank’soperating model and organisation structure, including establishment ofany necessary subsidiaries, their staffing and purpose.

• The existing landscape element to identify how current activity will beencompassed within the Bank

• The Bank’s recruitment needs and a recruitment plan, remunerationpolicies and structures.

• Identification of temporary premises for newly appointed ManagementTeam as well as permanent premises for when wider team is employed.

Market access • Initial suite of products/funds and investment activity that the bank wouldoperate in order to respond to SG’s Strategic Framework for the Bank.

• Target firms for these products and how the bank would find customersand how investments would be made, including investment through fundsand other financial intermediaries.

• What structures and staff are necessary within the Bank to support theseactivities.

Portfolio strategy • Strategy for establishing portfolio of assets via the products set out aboveand expected returns and profile of returns.

• Profile of investment and fit with budgetary support from the ScottishGovernment.

• Asset management strategy including management and sale of equityinvestments/fund investments and recycling of capital.

• Incorporation of any legacy assets and legacy funds or investmentprogrammes, and plans for how these would be accounted for in theBank.

Financial • Financial controls and systems necessary for making investments andhandling of returns including from debt holders.

IT architecture • Identification of suitable systems and applications to supportinvestment/asset management.

• The process for becoming ‘IT ready’, e.g., set up of email domains andprocurement of necessary systems in other areas.

Risk managementand compliance

• Consideration of risk management and compliance frameworks, systemsand controls, as well as identifying responsible owners.

• Consideration should also be given to how data will be managed.

People strategy • Strategy for staffing the Bank, including what staff are necessary,remuneration and conditions, fit with investment strategy.

• On-going development of staff as the Bank is established.• Practical considerations for staff – location, IT, pension arrangements, etc.

Monitoring andreporting

• Identification of key performance indicators and governance/reporting,both internally and externally.

• How the report and relationship will work with the Advisory Board andScottish Government, including any data sharing and confidentialityagreements necessary.

References

47

Appendix F References

Scottish Government (2017), A Nation with Ambition: The Government’s Programme for Scotland2017-18 (http://www.gov.scot/programme2017)

Mazzucato, M. and Penna, C. (2016), “Beyond market failures: the market creating and shapingroles of state investment banks”, Journal of Economic Policy Reform, Volume 19 (issue 4): 305-326,(www.sussex.ac.uk/spru/documents/2014-21-swps-mazzucato-and-penna.pdf)

Mazzucato, M. and Macfarlane, L, (2017), “Patient strategic finance: opportunities for investment-ledgrowth in the UK”. UCL Institute for Innovation and Public Purpose, Working Paper Series (IIPP2017-05) www.ucl.ac.uk/bartlett/public-purpose/wp2017-05

Scottish Government (2015), Scotland’s Economic Strategy (https://beta.gov.scot/policies/economic-growth)

Macfarlane, L. and Mazzucato, M. (2018), “State investment banks and patient finance: Aninternational comparison”, UCL Institute for Innovation and Public Purpose Working Paper, IIPP-WP2018-01.

Mazzucato, M. and Macfarlane, L. (2018), State Investment Banks: Selected International CaseStudies which has been published by Scottish Government alongside this Implementation Plan.

Scottish Fiscal Commission (2017), Scotland's Economic and Fiscal Forecasts December 2017,(http://www.fiscalcommission.scot/publications/scotlands-economic-and-fiscal-forecasts/scotlands-economic-and-fiscal-forecasts-december-2017/)

Office for Budget Responsibility (2017), Economic and fiscal outlook – November 2017,(http://obr.uk/efo/economic-fiscal-outlook-november-2017/)

Scottish Government (2018), Scotland's place in Europe: people, jobs and investment,(https://beta.gov.scot/publications/scotlands-place-europe-people-jobs-investment/)

Scottish Government (2017), Council of Economic Advisers: building our industrial strategy,(https://beta.gov.scot/publications/uk-government-green-paper-building-our-industrial-strategy/)

Rowlands, C. (2009), The Provision of Growth Capital to UK Small and Medium Sized Enterprises(http://lincscot.info/wp-content/uploads/2016/12/rowlands-growth-capital-review.pdf)

Buffini, D. (2017), Patient Capital Review: Industry Panel Response, UK Government: London, UK(www.gov.uk/government/publications/patient-capital-review)

Scottish Government(2015), The Market for SME Finance in Scotland,(www.gov.scot/Publications/2015/08/3776)

British Business Bank (2015), Equity Research Report: Review of Equity Investment in SmallBusinesses, (http://british-business-bank.co.uk/wp-content/uploads/2015/03/050315-Equity-report-FINAL.pdf)

McKinsey (2010), Women Matter,(www.asx.com.au/documents/media/2010_mckinsey_co_women_matter.pdf)

The Federation of Small Businesses (2016), Woman in Enterprise: The Untapped Potential,(https://www.fsb.org.uk/docs/default-source/fsb-org-uk/fsb-women-in-enterprise-the-untapped-potentialfebc2bbb4fa86562a286ff0000dc48fe.pdf?sfvrsn=0&sfvrsn=0)

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